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Good morning, it’s a pleasure to be speaking here today. And It’s a pleasure to speak with so many leading figures from across the European and Global derivatives market at what is still a time of great market and regulatory uncertainty.
Across the financial sector, we still live under the shadow of the financial crisis just over four years ago.
Whereas 2008 was a crisis of private and banking debt, today that crisis has transformed into one of sovereign debt.
As everyone here knows, the instability in the Eurozone continues to undermine confidence and growth across all our economies. Not just across Europe, but across the world.
Resolving the Eurozone sovereign debt storm is the immediate crisis that we all have to deal with, and we are as eager as our Euro area counterparts to see a comprehensive resolution to the crisis.
And in the same spirit we are eager to work with our European counterparts to remedy the regulatory failures that precipitated the worst crisis in almost a century.
Reform not just in the derivatives market, but across the financial sector, helping us all build on the vital strengths of the industry.
Importance of the financial sector
Here in the UK, the financial services sector continues to play a critical role in our economy…accounting for 10% of UK GDP, employing over 2 million people, and providing indispensable services to millions of people and businesses across the country, Europe, and global markets.
The European financial sector as a whole continues to play a critical role in underpinning and supporting the functioning of the Single Market.
Channelling the funds of savers to investment opportunities, transforming our bank deposits into loans to our businesses, and helping businesses and individuals manage risk.
Helping European Governments raise almost €1 trillion in bond markets in 2010,
Helping European companies raise almost €3 trillion in funds since 2006,
And helping EU citizens save over €6 trillion in current and savings accounts.
These are essential services the financial sector provides to the wider economy. Underpinning growth and prosperity across all sectors of the European economy, and across all regions of the EU.
And the derivatives market is of course critical to that function.
Improving market efficiency…
Reducing transaction costs…
And providing financial and non-financial companies with the capacity to manage risk.
The UK sits at the very heart of that market. A global centre for derivatives.
With a global share of interest rate derivatives of almost 50%, compared to 24% in the US.
The second largest centre for exchange traded futures and options…
Strengths which have encouraged the likes of the Chicago Mercantile Exchange considering opening a futures exchange here in London.
But in the post-crisis financial storm, derivatives have often been targeted for retribution rather than reform.
Caricatured as the financial sector’s “weapons of mass destruction”, despite the fact that they are used by everyone, everywhere, every time they have sought hedge risk and secure protection against unexpected events.
But hedging is as old as finance itself.
In the early 19th Century, they helped farmers to protect themselves against volatile price fluctuations…
Of course it wasn’t limited to the UK…by the end of the century, the Chicago Produce Exchange had pioneered commodity hedging right across the US…
And today, the global exchange market provides millions of investors protection against default risk, currency risk, interest rate risk and catastrophe risk to name a few.
But there have always been questions about these markets.
A survey from 1931 gives a flavour of some of the commodity markets in London and I quote: “Dealing in futures has a legitimate place in trading operations, but it is an operation which sometimes has all the inconsequence and all the thrill of a pure gamble.”
It’s why we need to constantly remake the case about the value that they add.
If I return to that 1931 survey…this debate has resonance today with the lobbying over the regulation of commodity markets including derivatives.
It’s why we need to make sure that these markets function efficiently, meeting the needs of users, without posing an undue risk to wider financial stability.
This is why it is vital that we learn the lessons of the crisis to remedy some of the inherent failures in regulation of the market.
In particular, the financial crisis vividly exposed the shortcomings in transparency and management of counter-party credit risk in the OTC market.
A market which had exploded in size in the years preceding the crisis.
But even as we fix those past failures, we also have to ensure that we keep pace with evolving markets.
As we drive forward regulatory reform, we need to learn the lessons of yesterday, but also recognise that today’s markets could trigger tomorrow’s financial crisis.
Of course, there are those who argue that regulatory reform is the enemy of growth…that we should postpone, or water down reform.
But we reject that argument outright - ineffective regulation and supervision of banking led to a massive contraction in the UK, European and global economy.
A stable, resilient, innovative, efficient, and competitive financial system is the vital precondition for sustainable economic growth.
And it’s the UK Government that has been at the forefront of international efforts leading the regulatory reform agenda.
We are committed to regulation that builds on the strengths of the EU financial services industry, delivering a stable, sustainable, and competitive financial services sector that supports economic growth and meets users’ needs.
Strong, consistent and proportionate
But even as we pursue reform, not just in the derivatives market, but across the financial sector, we have a delicate balance to strike…
How to preserve the innovation that fuels the sector’s success, whilst securing long term stability?
It’s a difficult line to tread, but it means that as we reform, we have to ensure that regulation is consistent, evidenced based, proportionate, and promotes competition.
Inconsistent and discriminatory regulation merely divides markets into narrow silos, stifling open and competitive markets that are critical to financial sector growth.
Disproportionate regulation, based on political whim rather than economic evidence, merely restricts investment, leading to less choice and higher costs for investors and lower returns for business.
But proportionate regulation does not mean weak regulation.
We will continue to guard against those who will use reform to unpick tough minimum regulatory standards - reform has to be consistent and non-discriminatory.
Full, consistent and non-discriminatory implementation of regulatory reform is essential to ensure the stability of the international financial system, but also to protect free and open competition that allows all our sectors to thrive.
But as well as protecting open competition in financial services, we have to actively pursue opportunities to promote it.
Across the array of European financial market reforms, we are supporting the Commission, the European Systemic Risk Board and the ESAs in their duty to protect and promote the Single Market in financial services.
In the global derivatives market, as you’re already aware, we have a general consensus at the G20 that we need to move towards the central clearing of derivatives.
It will help mitigate risk, but yes there will be inevitable costs as participants have to post more collateral.
And these participants are almost always large, international, highly sophisticated financial firms operating across a large range of jurisdictions.
That’s why we need to think carefully about how best to implement central clearing - about how we are going to put principles into practice.
First and foremost it is essential that we are consistent across borders.
That’s why through EMIR we have worked hard to ensure a clear recognition of the principle of non-discrimination - derivatives should be cleared in any member state regardless of which currency they are denominated in.
It is because of our commitment to this principle that we are challenging the ECB’s location policy in the ECJ which will limit user choice and increase investors costs.
Furthermore, we have to ensure that we safeguard fair, open non discriminatory access and competition between trading, clearing, and settlement systems.
That is not to say we must mandate a particular model be it horizontal or vertical.
Users must be able to choose where they trade, clear and settle; and not be constrained to using one provider for all these services.
Fair and open competition is critical to delivering efficient systems that are responsive to users’ needs, reducing costs for market participants, and boosting growth across the financial system and the real economy.
At the same time, we must also be aware of the potential dangers involved in concentrating risk in clearing houses. That’s why we have pushed for robust risk management requirements to help mitigate against this in EMIR.
But EMIR also only applies to over the counter derivatives.
We believe that the obligations and safeguards we are applying to OTC derivatives must also apply to exchange traded derivatives.
It makes no sense for the same basic product to have different obligations. We must close this loophole if the regulation is to have credibility, avoid arbitrage, reducing systemic risk and establish a competitive market in post trade financial services.
So we welcome the Commission’s proposals in the MiFID review to complete the work started in EMIR by extending the application of two-way open access requirements between CCPs and trading venues to all financial instruments.
Indeed, through MifID we have a huge opportunity to promote competition across the Single Market in financial services.
We have already seen the beneficial impact MiFID has had in lowering costs and spurring growth in equity markets through competition, and it is right that we update the directive for the significant changes we’ve seen across the market in recent years.
The introduction of the Organised Trading Facility - or OTF - is a bold step and should enable Europe to bring a significant proportion of the OTC derivatives market onto regulated, organised venues, in line with G20 objectives.
But reform has to be considered and evidence based.
For instance, whilst it is clear that greater transparency has had a positive effect in equity markets, extreme care is needed to ensure that transparency requirements are carefully designed to work for other, less liquid, asset classes. The success of the OTF category depends on this.
Similar care is needed in updating MiFID to reflect substantial changes in the market place in recent years such as high frequency trading.
For that reason, the UK is again leading the way through its Foresight project which is undertaking a detailed assessment of how computer trading may evolve and how this will affect market quality and stability.
Open third country access
But even as we take steps to promote the single market within Europe, we must not erect barriers outside it.
That’s why we are so concerned about the impact of provisions in MiFID and other financial services legislation requiring strict equivalence.
On the basis of the current proposals, it seems that no third country would meet the necessary standards.
From the moment that MiFID is passed and until equivalence decisions are taken, it would close the EU market entirely to any new third country firm, as well as choking off opportunities for our firms in some of the strongest and fastest growing emerging economies.
At a time when we have to do everything we can to attract investment to support the economic recovery we cannot cut ourselves off from the rest of the world.
Of course this works both ways. We have to resist proposals that seek to raise barriers to UK or European investment in the rest of the world.
Which is why we are concerned, along with many other countries, about the extra-territorial application of the Volcker Rule as currently drafted.
There is a significant risk that the Rule will restrict US banks from trading in non-US sovereign debt, and a risk that non-US banks may be restricted in their ability to transact with US investors.
We are committed to supporting and maintaining a successful financial services centre, not just here in the UK but across the EU.
Ensuring that we continue to attract the world’s most ambitious and innovative financial services companies to our markets…
Whilst also seizing on new opportunities in global market and in some of the fastest growing emerging economies.
But if the global financial sector is to continue to succeed, grow, and sustain vital services to the rest of the economy, then we have to reform regulation to underpin its stability.
We have to safeguard the innovation and success of the financial services sector, without putting the wider economy at risk.
And it’s the UK that has been leading the way to ensure that we implement tough, consistent and non-discriminatory reforms that safeguard the stability, openness and competitiveness of the European and global financial system.
But our tough approach goes hand in hand with evidence based, proportionate regulation that maintains open and competitive markets, promoting the growth that Europe so desperately needs.
In London, Frankfurt, Milan, Paris, and cities across Europe, financial services are an essential foundation to a prosperous and sustainable economy, and a vital driving force in our collective pursuit of growth.
The financial crisis was a rude awakening for all of us about the risks posed by inadequately regulated financial markets.
But we also all know that a strong, resilient, and competitive financial services sector is an asset to our families, businesses and economies.