By Huw Jones
LONDON, Sept 2 (Reuters) - The trading of privately-arranged derivatives contracts must not be forced onto exchanges and there must be no penalty for choosing not to clear trades, Europe's derivatives industry said on Wednesday.
The European Union, as part of global efforts to make markets safer and learn from the credit crunch, is consulting on possible legislation for the sector in the 27-nation bloc.
It follows pledges made by the G20 group of industrial and emerging market countries in April for standardisation in credit derivatives markets and central clearing of trades to cut risk in the $600 trillion sector.
Clearing of credit default swaps has begun in Europe and the United States in response to the G20 calls.
Problems at U.S. insurer AIG, which had to be bailed out, and the demise of Bear Stearns and Lehman banks showed regulators how little detailed information they had on some parts of the derivatives market.
Bespoke OTC contracts are typically traded bilaterally out out of the public gaze, a practice which the industry defended.
"The real economy faces diverse risks and depends on privately negotiated derivatives to address them effectively. As long as risk itself is not standardised, then tailored instruments will remain important," said Robert Pickel, chief executive of the International Swaps and Derivatives Association.
ISDA, the Securities Industry and Financial Markets Association, and the London Investment Banking Association published a joint response to the EU's consulation that was conducted by its executive European Commission.
The Commission will make definitive policy proposals by year-end, but the industry already fears that pressure for standardisation of contracts will go too far.
"We believe the regulatory focus should be on process uniformity, not product uniformity," Pickel said.
The EU is expected to insist that brokers that don't clear trades face extra capital charges.
The industry groups said they were not in favour of "additional new penalties" for contracts that are not cleared, saying existing capital charges were already high enough.
The United States has its own proposals for regulating derivatives but has gone a step further than the EU by saying OTC derivatives trading should shift to an exchange to increase transparency wherever possible.
The European Commission says such a step needed more study.
The three groups said exchange trading was not needed to promote more standardisation and "it certainly would not insulate our financial system from risk or reduce losses in a challenging environment".
Last week the Association of Corporate Treasurers said non-financial companies using derivatives to hedge risks would need to keep large amounts of extra financing if they are caught up in the regulatory attempts to cut risk. (Reporting by Huw Jones, editing by Stephen Nisbet)