EU Credit Default Swaps To Be Cleared By Central Counterparties

by Ulrika Lomas, Tax-News.com, Brussels

04 August 2009

As of July 31, credit default swaps (CDS) relating to European entities and indices based on these entities will be cleared through central counterparties regulated in the EU. This comes in response to Commissioner McCreevy's call to reduce the risks inherent in this market. CDS are financial products designed to insure the buyer against losses caused by a credit event (e.g. a default) affecting a given entity, and until now had been managed bilaterally between buyer and seller.

Internal Market and Services Commissioner Charlie McCreevy said: "Back in October 2008, I called upon the industry to reduce the risks inherent in the credit default swaps market, in particular by moving the clearing of these contracts onto a European central counterparty (CCP). The financial crisis highlighted a number of problems in the credit default swaps market, especially where transparency, market concentration and risk mitigation were concerned. Clearing through central counterparties is key to improving risk management and to increasing the stability of the financial system. I am pleased that the extraordinary efforts by the industry and service providers have made it possible that two European CCPs are starting to clear these products now, with a third aiming to launch its service by the end of the year. The existence and the use of more than one CCP is essential for the proper development of a safe and competitive environment."

In response to the Commission's call for central clearing of credit default swaps (CDS), ten major dealers committed to clear CDS on European reference entities, and indices based on these entities, through one or more central counterparties (CCPs) established and regulated in the European Union by July 31, 2009. The Commission has set up a working group, involving dealers, the buy-side (e.g. banks, insurance companies and funds), CCPs and supervisors, to monitor the orderly roll-out of this commitment.

The Commission welcomed the fact that, through the International Swaps and Derivatives Association (ISDA), dealers have developed the standards necessary to allow central clearing for European CDS, in particular standards for the treatment of the restructuring credit event incorporated in the so-called ‘Small Bang’ Protocol, to which the vast majority of market participants has already adhered. The Commission also welcomed the considerable efforts made by the CCPs to implement these standards so as to offer a solution by the set deadline. Two European CCPs (ICE Clear and Eurex Clearing) have already obtained the necessary regulatory approvals and are now offering their services while a third (LCH.Clearnet SA) is expected to follow by year-end. The Commission, therefore, expects that, as of July 31, dealers will live up to their commitment and will start using all available CCPs for all eligible trades.

The Commission will monitor the migration of the CDS onto CCPs and will take account of the progress made by market participants in the CDS area when formulating its policy orientations for over-the-counter (OTC) derivatives in general. The Commission intends to publish these policy orientations by the end of October 2009. To this end, the Commission is currently running a public consultation and will also organise a high-level conference entitled "Derivatives in crisis: Safeguarding financial stability" on September 25.

Since CCPs constitute an essential post-trading infrastructure, high supervisory standards are indispensable to ensuring that CCPs have in place proper risk management procedures, according to the Commission. However, in order to be able to offer their services on a pan-EU scale, central counterparties had to undergo comprehensive scrutiny and to obtain multiple authorisations. In view of the Recommendations recently agreed by the Committee of European Securities Regulators (CESR) and the European System of Central Banks (ESCB) and with regard to a proper functioning of the single market, the Commission says it will consider ways to facilitate this process along the lines announced in its Communication of May 27 on European financial supervision.

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