LONDON, Feb 29 (Reuters) - The derivatives market and regulators should work together to decide which contracts in the $700 trillion sector must be centrally cleared to curb risks and improve transparency, global regulatory body IOSCO said.
The International Organisation of Securities Commissions said on Wednesday banks and clearing houses should be given a "bottom up" role, meaning a product would be cleared if a clearing house made a request, after approval from a regulator.
IOSCO said there should also be a "top down" option, meaning supervisors can order banks and clearing houses to clear certain broad classes of products even if a clearing house has yet to be licensed to do so.
IOSCO was publishing its final recommendations on mandatory clearing of off-exchange derivatives contracts called for by leaders of the world's top 20 economies.
It reflects what is already taking place in Japan, the United States, Hong Kong, Singapore and the European Union.
The industry wants to avoid being faced with diktats from regulators and having to clear products which clearing houses or banks feel are unsuited for clearing.
"Authorities implementing a mandatory clearing regime should consider using a bottom-up approach to determine products that are subject to a mandatory clearing obligation," the IOSCO report said.
"In assessing a proposal for a new clearing obligation under the bottom-up approach, a determining authority should conduct a public consultation," IOSCO said.
However, regulators have included the "top down" approach as a form of backstop so that the industry cannot avoid clearing because it may not be profitable even though it would help curb risk and improve transparency in markets.
"Those central counterparties that are commercial for-profit entities might be driven by revenue and commercial considerations, which may not necessarily be aligned with the core purpose of a CCP, that is risk reduction," Deutsche Bank said in a research note to clients last November.
"A central counterparty might thus not want to clear a contract even though this could enhance risk reduction in derivatives markets," Deutsche Bank said.
IOSCO said exemptions from mandatory clearing should be narrowly defined and limited.
IOSCO is an umbrella group for all the world's top securities regulators like the U.S. Securities and Exchange Commission, Britain's Financial Services Authority and Japan's Financial Services Agency.