News
BackAlmost unnoticed by the general public, the Commission devotes a new Communication to a volatile subject, which is regarded as one of the main causes for the current finance and economic crisis, the so-called derivatives. No other example would be better suited to illustrate the economic and social undesirable developments of the past decades: the belief in free, unregulated markets and in the alleged ingenuity of the financial industry. A dangerous misbelief, for which the labour force and the citizens worldwide are now expected to pay the price.
Derivatives (Latin derivare = derive) get their name because their value is derived from an underlying value. There are a number of possible underlying values, such as shares, commodities, interest rates or loans. In very simple terms, the principle could be compared to a bet. One contracting party for example places its bet on a rising share price (or another event), the other party bets against it. It makes, however, sense to use derivatives for airlines and industrial firms to hedge against price fluctuations of important raw materials.
Welcome to the world of casino capitalism
The “ingenuity” of the financial industry, which had been also politically promoted during the heyday of neoliberalism, however, has led to developments, which have nothing in coming with the real needs companies have. Experts are talking of a decoupling of the financial economy from the real economy, which in daily use is also called casino capitalism. A short glance at the figures shows what is meant by this. According to calculations by experts, the trade volume of financial derivatives in 2006 was in Europe alone 84 times higher than the total sum of all services and goods produced in the real economy. Speculation has left the real economy far behind.
Betting in grand style: EUR 500,000 billion per year without supervision
These are sums, which strain the imagination. If the volume of the traded derivatives was still EUR 71 trillion in 1998, this value over the next 10 years exploded to incredible EUR 568 trillion. This corresponds approximately to 2000 times the annual economic output of Austria (Austria’s Gross Domestic Product 2008: EUR 285 trillion). There is also the fact of another trend, which has significantly contributed to the current financial crisis: the trade with derivatives is to a large extent taking place in back rooms, far beyond any control by governmental supervisory authorities. Of EUR 568 trillion trade volume, about EUR 500 trillion accounted for derivative transactions, which were not traded at public stock markets; in technical jargon these are called “Over-the-Counter” (OTC). As in times long gone, the parties mutually agree the conditions “over the counter” and nobody – and that includes supervisory authorities – has any insight into what is happening. Such deals are concluded by telephone or electronically via “private” trader networks; any recordings of such transactions are - as a matter of course - also regarded as a private matter.
Credit derivatives almost led to the collapse of the financial world
The analysis given by the Commission in its Communication and in an accompanying working document is definitely worth reading. The Commission concludes that the use of derivatives without a real reason not only has to be rated as pure speculation, but that it also increases the susceptibility to risk of the entire finance and economic system. Most significant is the importance of the role of credit derivatives (Credit Default Swaps CDS), which not only toppled the US giants Bear Sterns, Lehman Brothers and AIG, but also rocked the entire global economy. This concerns bets whether a certain company will be able to repay its debt. The hype over credit default swaps was triggered by hedge funds and investment banks, which regarded classic corporate bonds as too boring and too little profitable.
Nobody knows the risk - the state will sort things out: workers and citizens pay the price
“No economy can thrive if nobody is prepared to take a risk”, states the Commission in its Communication. The problem with credit derivatives, however, was that investors did not have enough information about the underlying risk (will the company be able to repay its credits?) and blindly relied on the assessment of rating agencies, which unfortunately in many cases got it completely wrong. The fact that these transactions were mainly taking place without public supervision meant that nobody gained an insight in the dimension and the macroeconomic risks. When the entire house of cards collapsed it was left to the public purse to take over the risk, which today is passed on to the labour force and to tax payers.
Commission: lots of voluntariness and plenty of encouragement
One should think that these undesirable developments were reason enough for the Commission and the Member States to decisively intervene. In actual fact, however, the Commission once again seems to be relying on voluntariness: it recommends in its Communication to stricter standardise derivatives and to trade via central “clearing houses”. Together with the powerful financial industry it has negotiated a deadline until 31st July 2009, by which credit default swaps have to be processed via a central clearing house. If this is not done in a satisfactory manner, the Commission reserves the right to undertake further legal steps. Only “mid-term” considerations have been made for interest rate swaps or currency and raw material contracts – instruments, which in the opinion of experts considerably contribute to the large price fluctuations for oil and food products.
EU stabs USA in the back over regulations: rules light from Brussels
The reason why the recent bowing of the Commission before the lobby of the financial industry is particularly worrying lies in the fact that across the Atlantic, the USA, under the Obama administration, aims at applying a significantly stricter approach against derivatives. As a result, the USA intends to strictly regulate the derivatives trade; that is why the US government only recently decided to force the particular complex trade with credit derivatives on to publicly accessible stock market platforms. As in this case the financial sector fears a painful decline in sales caused by a lower demand for risk papers, it is up in arms about this plan.
The European Commission has a different take on this. It wants to use the more decisive approach of the USA to gain business for Europe, thereby stabbing the Americans in the back. London and New York account for the largest share in the global derivative trade; a more relaxed regime in Europe could attract business from across the Atlantic. Consequently, also the lobbying associations International Swaps and Derivatives Association and European Banking Federation are relieved and are very happy with the proposals of the European Commission.
The Communication of the Commission is currently subject of a public consultation until 31st August. A public hearing is planned for 25th September. The intention is to publish the results before the end of the year; then “appropriate” initiatives will be introduced and “when justified” draft proposals will also be made.
Commission Communication on derivatives (currently in English only)
Working document of the Commission on derivatives (in English only)
Consultation document of the Commission on derivatives (in English only)
Welcome to the world of casino capitalism
The “ingenuity” of the financial industry, which had been also politically promoted during the heyday of neoliberalism, however, has led to developments, which have nothing in coming with the real needs companies have. Experts are talking of a decoupling of the financial economy from the real economy, which in daily use is also called casino capitalism. A short glance at the figures shows what is meant by this. According to calculations by experts, the trade volume of financial derivatives in 2006 was in Europe alone 84 times higher than the total sum of all services and goods produced in the real economy. Speculation has left the real economy far behind.
Betting in grand style: EUR 500,000 billion per year without supervision
These are sums, which strain the imagination. If the volume of the traded derivatives was still EUR 71 trillion in 1998, this value over the next 10 years exploded to incredible EUR 568 trillion. This corresponds approximately to 2000 times the annual economic output of Austria (Austria’s Gross Domestic Product 2008: EUR 285 trillion). There is also the fact of another trend, which has significantly contributed to the current financial crisis: the trade with derivatives is to a large extent taking place in back rooms, far beyond any control by governmental supervisory authorities. Of EUR 568 trillion trade volume, about EUR 500 trillion accounted for derivative transactions, which were not traded at public stock markets; in technical jargon these are called “Over-the-Counter” (OTC). As in times long gone, the parties mutually agree the conditions “over the counter” and nobody – and that includes supervisory authorities – has any insight into what is happening. Such deals are concluded by telephone or electronically via “private” trader networks; any recordings of such transactions are - as a matter of course - also regarded as a private matter.
Credit derivatives almost led to the collapse of the financial world
The analysis given by the Commission in its Communication and in an accompanying working document is definitely worth reading. The Commission concludes that the use of derivatives without a real reason not only has to be rated as pure speculation, but that it also increases the susceptibility to risk of the entire finance and economic system. Most significant is the importance of the role of credit derivatives (Credit Default Swaps CDS), which not only toppled the US giants Bear Sterns, Lehman Brothers and AIG, but also rocked the entire global economy. This concerns bets whether a certain company will be able to repay its debt. The hype over credit default swaps was triggered by hedge funds and investment banks, which regarded classic corporate bonds as too boring and too little profitable.
Nobody knows the risk - the state will sort things out: workers and citizens pay the price
“No economy can thrive if nobody is prepared to take a risk”, states the Commission in its Communication. The problem with credit derivatives, however, was that investors did not have enough information about the underlying risk (will the company be able to repay its credits?) and blindly relied on the assessment of rating agencies, which unfortunately in many cases got it completely wrong. The fact that these transactions were mainly taking place without public supervision meant that nobody gained an insight in the dimension and the macroeconomic risks. When the entire house of cards collapsed it was left to the public purse to take over the risk, which today is passed on to the labour force and to tax payers.
Commission: lots of voluntariness and plenty of encouragement
One should think that these undesirable developments were reason enough for the Commission and the Member States to decisively intervene. In actual fact, however, the Commission once again seems to be relying on voluntariness: it recommends in its Communication to stricter standardise derivatives and to trade via central “clearing houses”. Together with the powerful financial industry it has negotiated a deadline until 31st July 2009, by which credit default swaps have to be processed via a central clearing house. If this is not done in a satisfactory manner, the Commission reserves the right to undertake further legal steps. Only “mid-term” considerations have been made for interest rate swaps or currency and raw material contracts – instruments, which in the opinion of experts considerably contribute to the large price fluctuations for oil and food products.
EU stabs USA in the back over regulations: rules light from Brussels
The reason why the recent bowing of the Commission before the lobby of the financial industry is particularly worrying lies in the fact that across the Atlantic, the USA, under the Obama administration, aims at applying a significantly stricter approach against derivatives. As a result, the USA intends to strictly regulate the derivatives trade; that is why the US government only recently decided to force the particular complex trade with credit derivatives on to publicly accessible stock market platforms. As in this case the financial sector fears a painful decline in sales caused by a lower demand for risk papers, it is up in arms about this plan.
The European Commission has a different take on this. It wants to use the more decisive approach of the USA to gain business for Europe, thereby stabbing the Americans in the back. London and New York account for the largest share in the global derivative trade; a more relaxed regime in Europe could attract business from across the Atlantic. Consequently, also the lobbying associations International Swaps and Derivatives Association and European Banking Federation are relieved and are very happy with the proposals of the European Commission.
The Communication of the Commission is currently subject of a public consultation until 31st August. A public hearing is planned for 25th September. The intention is to publish the results before the end of the year; then “appropriate” initiatives will be introduced and “when justified” draft proposals will also be made.
Commission Communication on derivatives (currently in English only)
Working document of the Commission on derivatives (in English only)
Consultation document of the Commission on derivatives (in English only)