Europe moves to end financial market ‘Wild West’

The European Union announced new rules Wednesday to tame a ‘Wild West’ of speculative high-risk trading instruments blamed for the worst global financial crisis since the 1930s’ Great Depression.

Two years to the day since the collapse of US investment bank Lehman Brothers, the European Commission proposed new rules to ensure more transparency in over-the-counter (OTC) derivatives and the “short-selling” of securities.

“No financial market can afford to remain a Wild West territory,” said EU Financial Services Commissioner Michel Barnier, warning that OTC derivatives have a “big impact” on the prices of products ranging from mortgages to food.

“The absence of any regulatory framework for OTC derivatives contributed to the financial crisis and the tremendous consequences we are all suffering from,” he said.

The goal is to prevent a failure in any one market from reverberating across the financial system, as the collapse of Lehman Brothers did, Barnier said.

The new rules would require investors to report derivatives trades in the 27-nation EU to central data centres. Such reporting is not required at the moment.

The EU’s executive arm also wants to set up a tracking system for “short-selling,” the sale of a security not owned by the seller in the hope of turning a profit by buying it back later at a lower price.

The rules would give national regulators, in coordination with new EU-wide supervisors, the power to restrict or ban short-selling in “exceptional situations” in order to prevent a crisis.

The EU especially wants to curb the scope for short-selling in sovereign credit default swaps, a derivative sometimes seen as a form of insurance against the risk of default.

In May, Germany banned so-called “naked” short-selling, a highly speculative trade which has been blamed for driving markets to extremes, sowing panic at national and international level for the likes of weaker eurozone members such as Greece.

“In normal times, short selling enhances market liquidity and contributes to efficient pricing but in distressed markets, short selling can amplify price falls, leading to disorderly markets and systemic risks,” Barnier said.

The new rules foresee an oversight role for the pan-European financial supervisors that are scheduled to being operating on January 1 following approval by the European parliament.

The proposals have to be approved by EU states and the European parliament, with the goal of launching the new rules in 2012.

Barnier later laid out his scheme to lawmakers, after which the chairwoman of the parliament’s economic affairs committee, Sharon Bowles, said his latest proposals would “immediately put … to the test” a new EU banking authority to come in next year that has already proved hugely divisive.

France and Germany were the big drivers behind efforts which encountered fierce resistance in London, which together with New York and Chicago count as the key global financial markets, and notably for derivatives trading.

Forty percent of the global derivatives trade is conducted in the City of London, according to the British ambassador to the EU.

The EU’s proposed legislation comes after tough changes announced in the United States.

On Sunday, world economic powers also agreed on a new base framework for the amount of capital the commercial banks must hold to help avert any new financial crisis.

That decision, and Wednesday’s announcement, are the latest steps in a series of moves at the EU, US and global level to set out new rules for banks, financial markets and regulators in response to the chaos and public outrage caused by the financial crisis.

London is also now declaring itself “happy” with an emerging deal to try and control non-EU hedge funds.