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IEA warns OTC reforms could hamper price discovery

Warns Volcker Rule threatens to lower liquidity.

December 10, 2010 2:09 by

The proposed reforms to the over-the-counter (OTC) derivatives markets in the United States and Europe could hamper price discovery and increase costs for end users, the International Energy Agency said on Friday.

In its monthly report on the oil market, the body which advises industrialised governments on energy policy, raised four main concerns about the proposed overhaul of the opaque $583 trillion industry which trades via privately-negotiated contracts rather than on exchanges.

The IEA said the Volcker rule, which will prohibit U.S. banks from proprietary trading, could negatively change the structure of the OTC derivatives market by lowering liquidity and compromising the process of price discovery and risk transfer function of the market.

Costs for end-users could also rise due to uncertain margin requirements and if counterparties passed on some of the clearing costs to buyers, it warned.

The IEA added that the OTC market was fundamentally different from the futures market and should not be regulated in identical fashion and raised concerns about the high failure rate of exchange trading models in less liquid instruments.

G20 leaders agreed last year that all standardised OTC derivatives contracts should be traded on exchanges or electronic platforms and cleared through central counterparties by the end of 2012.

The financial crisis has prompted policymakers around the world to tighten regulation in order to reduce systematic and counterparty risk and increase the transparency of markets.

Commodity-based derivatives accounted for 0.5 percent of the total notional value of the global OTC market at the end of June 2010, according to the Bank of International Settlements.

At the peak at the end of June 2008, commodity-related derivatives accounted for 2 percent of the total market.

(Editing by James Jukwey)

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