A4-0207/95

Resolution on Parliament's recommendations to the Commission concerning a legislative proposal on financial derivatives: their present role on capital markets, their advantages and risks

The European Parliament,

- having regard to Rule 148 of its Rules of Procedure,

- having regard to the deliberations of the public hearing organized by its Subcommittee on Monetary Affairs on this subject on 21 March 1995,

- having regard to the legislative work in progress in the US, Japan and EU as well as the proposals from the Basle Committee on banking supervision,

- having regard to its resolution of 15 December 1993 on international monetary cooperation within the framework of the easing of restrictions on capital markets ((OJ C 20, 24.1.1994., p. 74.)) and, in particular, its proposals and recommendations concerning financial derivatives,

- having regard to the response of the Commission in the form of a Communication on Derivatives, Capital Movements and the Debate on Financial Regulation (SEC(95)0587),

- having regard to the report of the Committee on Economic and Monetary Affairs and Industrial Policy (A4-0207/95),

A. conscious of the rapid - and since 1989 accelerating - expansion of financial derivative markets in the past two decades, generated by the need for institutions to hedge against financial risk following the collapse of the Bretton Woods system of exchange rate determination,

B. aware of the substantial increase in the share of European business in the relevant global market,

C. noting the spirit of innovation inherent in the development of financial derivatives instruments and the resulting variety, and in certain cases complexity, of these instruments which may render comprehension of the associated risks problematic for the common user,

D. taking into account the parallel development of an Exchanges-oriented and an over-the-counter (OTC) market, each one catering to different kinds of customer needs and presenting its own operational and supervisory problems,

E. convinced that financial derivatives, used as tools of risk-management, have provided real benefits in the form: (a) of a more efficient allocation of resources, and (b) of risk-sharing, by lowering the cost of risk intermediation via the unbundling of formerly indivisible risks,

F. recalling, however, the concern expressed in its abovementioned resolution of 15 December 1993 about increased risks threatening the financial pyramid as a result of the rapid expansion of derivative markets as well as concern expressed in other parliamentary fora world-wide and in particular in the US Congress,

G. whereas the protection of small savers who entrust the management of their investments to banks and financial companies should be taken fully into account by the Community and national authorities,

H. concerned about the growing use of financial derivatives for purely speculative purposes,

I. whereas it is unclear in some Member States whether government bodies, building societies and other parties are legally entitled to effect derivative financial transactions and whereas the legal status of (market) operators varies from one country to another,

J. noting that derivative financial instruments are also used, especially by dealers and investors, to assume unhedged and often strongly leveraged proprietary positions in anticipation of favourable price movements; that special risks are inherent in this kind of activity; that very large losses are both possible and have in fact materialised in the course of such trading; that ethically dubious practices have been disclosed in some recent incidents involving serious losses for customers or intermediaries,

K. conscious that no ironcast guarantee against the possibility of such losses detonating a chain-reaction of bankruptcies, that might assume the proportions of a major systemic risk, can exist but willing, nevertheless, to minimise the likelihood of such an event occurring and protect public funds which might otherwise have to be mobilized in a rescue operation,

L. emphasizing, therefore, the necessity for firms and organisations operating in this market to assume an even higher degree of responsibility and internal control, in the first instance by ensuring that all members of management and staff involved are completely knowledgeable about the instruments they are dealing with,

M. acknowledging the initiative and continuing efforts of a number of firms and of professional organisations, both in Europe and the US, to formulate a risk management system and voluntary rules of professional responsibility in the areas of internal controls and of safe and proper conduct of the derivatives business for managers, dealers and users alike,

N. eager for the widest possible dissemination and adoption among practitioners of best-practice methods in the spirit of the previous two paragraphs, and aware of the significant discrepancies in the various supervisory and regulatory regimes worldwide,

O. unwilling to burden the derivatives business with discriminatory, unnecessary, excessive or ill-conceived regulations; desiring that the novelty and versatility of financial derivative instruments be given the fullest possible scope consistent with the security of transactions and the stability of the financial markets; supporting the continuation and strengthening of co-operation, such as has already emerged, between professional bodies and public authorities in this area,

P. eager to foster an environment characterised by fair competition, non- discrimination and equal access in order to capture the important benefits inherent in the proper use of derivatives through the continuous, smooth and safe functioning of the markets, which presupposes the harmonisation and updating of accounting, disclosure and supervisory rules on a European and, subsequently, on a global, scale in a manner having proper regard of the process of financial innovation and of its results,

Q. intent on reassuring the public in Europe that any anxieties it may have felt on the issue of safety and stability of financial markets under innovation are being dealt with at the highest possible level with all due care; intent on issuing a strong message towards those in authority in all main economic areas, and especially in the United States and Japan, on the need for world-wide co-ordination in order to reap the fruits of financial innovation in conditions of balanced expansion; calling, therefore, on the Basle Committee on Banking Supervision to step up and intensify its current activities to that effect,

R. endorsing the following goals governing supervision and regulation:

(a) maintenance of stability of the financial system,

(b) enhancement of the efficiency and competitiveness of EU banking and financial markets,

(c) protection of consumers from fraud and deceptive business practices,

(d) protection, as far as possible, of public funds from the risk of loss associated with mismanagement,

S. aware that the above goals in the area of derivatives will not be attained if the present national and Community regulatory and supervisory framework for financial markets is not substantial enhanced because:

(a) financial derivatives, due to their versatility, continuous innovation and global use, have increased risk management and systemic risk,

(b) financial derivatives have contributed to an evolution blurring the distinction between banks, financial intermediaries and specialized finance companies,

(c) the existing legislative procedure is unacceptably cumbersome in view of the speed of developments in the financial sector, under the impact of financial innovation throughout the world, in which derivatives play a central role,

1. Requests the Commission to bring forward in its annual work programme for 1996 proposals aimed at achieving the following results:

(a) to codify the proposals made so far by the various professional organizations on voluntary rules of conduct for managers, traders and users engaged in derivative financial instruments markets, to complement such rules where necessary and shape them into codes of conduct,

(b) to adjust the accounting and disclosure standards to the special characteristics of contingent liabilities and assets, and in particular of financial derivative instruments, in the certified accounts of companies, involving the greatest practicable use of mark-to-market methods with a view toward prompting member states to urgently clarify their legislation and bring it up-to-date and, on this basis, proceed to the harmonisation of accounting standards throughout the area of the internal market,

(c) to raise the educational standards among managers and traders dealing with financial derivative instruments both in financial intermediary and in end-user companies by setting up a unified professional examination on a European scale, and until such time as the preparation of this Examination is satisfactorily completed, to introduce material relating to derivatives in all existing relevant professional examinations,

(d) to strengthen the validity of netting arrangements covering financial derivative contracts and encourage the use of credit enhancement techniques, where appropriate, including industry initiatives to develop appropriate clearing facilities,

(e) to take steps so that measures taken under (a), (b), and (d) cover fully not only banks but all kinds of financial or non-financial companies dealing with derivatives, whether as intermediaries or as end-users, taking into account their size and specialisation;

In (a), (b) (d) and (e) stated above, the distinction between exchange- traded and over-the-counter (OTC) derivative instruments should be kept in mind and the relevant provisions be adapted accordingly;

2. Requests the Commission to consider the possibility of a mechanism by which the specific degree of risk associated with various types of financial derivatives can be assessed and publicly rated;

3. Is concerned about the concentration of financial derivative transactions in the hands of a few suppliers and calls on the Commission to investigate the possible implications of this concentration in the EU;

4. Asks the Commission to prepare and submit to the European Parliament and the Council regular reports on developments in financial derivative markets, making use of all available statistics and initiating the collection of additional statistics wherever needed and taking into particular account the quarterly reports of the Basle Committee on Banking Supervision;

5. Asks the Commission to prepare and submit to the European Parliament and to the Council a report on the possible systemic risks of derivatives;

6. Instructs the Subcommittee on Monetary Affairs of its Committee on Economic and Monetary Affairs and Industrial Policy to take immediate steps towards establishing contact, at the appropriate level, with the United States Congress and the Japanese Diet with a view to undertaking a joint, globally coordinated initiative in furtherance of the above aims, directed at the establishment of a global code of conduct in trading and use of financial derivatives;

7. Instructs its President to forward this resolution to the Council, the Commission, the European Monetary Institute, the Basle Committee on Banking Supervision, the United States Congress, the Japanese Diet and national parliaments currently engaged in investigations concerning derivative financial instruments.