LONDON, Oct 15 (Reuters) - Global regulators have reached a deal to ensure that privately-negotiated derivatives contracts are backed by enough capital in case of default, a British government minister said on Thursday.
"We have secured the agreement of global over-the-counter (OTC) derivatives supervisors for a major overhaul of bilateral collateralisation and anticipate a formal approval from industry next week," financial services minister Paul Myners told a conference on regulation.
"The absence of a central counterparty for credit default swaps meant there was no firebreak to prevent contagion. This could and should have been mitigated by bilateral collateralisation," Myners said.
Policymakers on both sides of the Atlantic are cracking down on the lightly-regulated $450 trillion OTC derivatives sector, seen as having played a role in amplifying the financial crisis and been at the heart of insurer AIG's problems.
The European Union's executive European Commission is due to come out with its policy thinking on regulating OTC derivatives markets in the 27-nation bloc next Tuesday.
U.S. lawmakers are also considering draft bills to tighten oversight of the sector.
The G20 group of countries agreed in September that OTC derivatives contracts should be traded on an exchange or platform, where appropriate, and centrally cleared by the end of 2012 at the latest.
Not all contracts can be standardised enough to be traded on an exchange or centrally cleared, which is why supervisors are keen to ensure that such contracts are still properly backed by capital in case of default by one party.
Users of OTC contracts, such as airlines which hedge currency or fuel price risks, have been campaigning to ensure they can still have bespoke contracts for their specific needs.
The UK is at the forefront in addressing counterparty risk in derivatives markets, Myners said.
"We need to ensure that all central counterparties in Europe are run to the same highest prudential operational standards. For 18 months we have calling for an EU directive on central counterparties," Myners said.
"This would also ensure a genuine single market for central counterparties services which plays such a vital role in reducing financial contagion," Myners said.
Central clearing of CDS contracts traded in Europe and the United States has already begun due to earlier pressure from the G20 but policymakers now want a wider range of OTC derivatives contracts centrally cleared.
(Reporting by Huw Jones, editing by Victoria Main)