By Huw Jones
LONDON, March 31 (Reuters) - European Union states want to extend a draft law curbing risk in privately negotiated derivatives to the whole sector, which could ultimately dent profitability of the world's first mega bourse merger.
The bloc is scrutinising European Commission plans to regulate how derivatives contracts traded in the $600 trillion over-the-counter (OTC) sector should be centrally cleared.
Its latest compromise, seen by Reuters, omits OTC from its title, meaning the law would cover all derivatives market.
Dealers said this would avoid having a law for just one part of a market, which they say would be hard to enforce. Exchanges sense an attempt to rip open their vertically integrated model to competition in clearing.
The draft law has become politically heated since Deutsche Boerse unveiled a $10.2 billion plan to merge with NYSE Euronext to create a vertically integrated group with 94 percent of futures trading in Europe.
Building a bigger derivatives footprint is a core driver of the merger to create the world's biggest exchange, one to compete with derivatives powerhouse CME. Over a fifth of tie-up synergies will come from clearing.
But banks say the merged group should be opened up to clearing competition. Extending the law's scope to regulating listed as well as OTC derivatives would achieve this goal.
It would make it easier for users to clear listed contracts transacted on Deutsche Boerse or Euronext's LIFFE derivatives platform elsewhere and not be locked into the group's clearers.
"The inclination among OTC derivatives fans like us is 'why differentiate between one derivative and another?'," said David Clark, chairman of the Wholesale Markets Brokers' Association.
"The big deal in all this is the competition element with Deutsche Boerse. This move to extend the scope of the draft law has got politics written all over it," Clark said.
FRANKFURT VS LONDON
Banks say competition in clearing for all derivatives is essential as the draft EU law will also make clearing of many OTC contracts mandatory from 2012.
Exchanges sense integrated business models are under threat.
"Some are trying to weaken vertical structures by creating clearing links with other structures. That creates systemic risk and shifts focus away from the real issue of dealing with OTC derivatives," an exchanges industry official said on condition of anonymity due to the sensitivity of the issue.
The battle between the "verticalists" and "horizontalists" in clearing is a decade old and has never resolved, with the same two countries pitted against each other today as back then.
Deutsche Boerse's home country Germany is against extending the scope of the draft law. Britain is pushing for the extension and, so far, has a majority of EU countries on its side.
But the battle is not over.
EU states have joint say on the measure with the European Parliament and Werner Langen, the German lawmaker who is steering the measure through the assembly, is against extending the scope, saying listed derivatives are already regulated.
Langen faces challenges from lawmakers who have filed amendments to extend the bill's scope. British lawmaker Kay Swinburne said access to a clearer should not be compromised by restrictions to trading only OTC contracts.
Parliament votes in committee next month on its text.
So far, the European Commission's financial services arm, which often brokers a deal on financial rules, is sitting on the fence but that could become less tenable as the executive's competition arm decides on the Boerse/NYSE merger.
EU Competition Commissioner Joaquin Almunia is concerned about Deutsche Boerse's "vertical silo" model whereby banks that execute trades on its platform end up having to clear and settle within the group.
The EU executive faces pressure to be consistent.
"Extending the scope of the law would open up the silos.
Many firms would probably like to see clearing choice across the board, but there are also efficiency synergies between clearing and trading," said Anthony Belchambers, chief executive of the Futures and Options Association, an industry lobby. (Reporting by Huw Jones; Editing by Dan Lalor)