Banks and companies that fail to report trading in over-the-counter derivatives face fines under rules being considered by the European Union.

The draft law would require traders to "report the details of any OTC derivative contract" they have entered into "no later than the working day following the execution" of the trade, according to a European Commission document obtained by Bloomberg News.

The 27 member states of the EU would have to enforce penalties that "shall include at least administrative fines" on those that do not comply, according to the plan. "The penalties provided for shall be effective, proportionate and dissuasive," said the document, which was dated Aug. 27.

European and U.S. regulators are pushing for tighter oversight of the $605 trillion over-the-counter derivatives market. The EU plan would require more of the products to be traded through central clearing houses. The commission, the executive arm of the EU, is scheduled to formally announce the proposals this month for discussion with the European Parliament and member states.

The proposal to move more OTC trades through central clearing houses may lead to higher costs for European banks and companies that use the products compared with those in the U.S., according to a European Commission impact assessment dated Aug. 26 and obtained by Bloomberg News. The extra costs would stem from the need to post collateral for the trades.

"If the substance of the proposal stays as it currently is, there is a danger that EU market participants may be at a disadvantage with respect to their U.S. counterparts," the impact assessment said. Under EU rules, policy proposals are accompanied by a report outlining the costs and benefits.

The sanctions could create an incentive to direct derivatives trading through companies not regulated in the EU region, Simon Gleeson, a financial regulatory lawyer at Clifford Chance in London, said in a phone interview.

"You could break the derivatives industry in two," Gleeson said. "What happens if hedge fund A in the Cayman Islands trades with hedge fund B in the Cayman Islands?"

Chantal Hughes, a spokeswoman for Financial Services Commissioner Michel Barnier, could not immediately be reached for comment.

The EU proposal is part of a package of laws intended to strengthen regulation after the worst financial crisis since the Great Depression. The derivatives plan is aimed at limiting losses in the event of a default by a major counterparty.

Collateral agreements were in place for "70% of OTC derivatives trades" in 2009, according to the impact assessment, which cited a survey by the International Swaps and Derivatives Association.

"Based on the ISDA survey, approximately $1.4 trillion of exposures in OTC derivatives remain uncollateralized," the commission report said. "In other words, the amount of leverage in the market is higher than should be the case given the amounts of collateral."

The draft rules, which are scheduled to take effect by the end of 2012, must be approved by finance ministers from the 27 member states and members of the European Parliament before they can become law.

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