As of today, credit default swaps (CDS) relating to European entities and indices based on these entities will start clearing through central counterparties regulated in the EU. This will reinforce financial stability by ensuring better risk management for European CDS, and comes in response to Commissioner McCreevy’s call to reduce the risks inherent in this market.
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 31 July 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 welcomes 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 welcomes 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 today, 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, as announced on 3 July in its Communication on “Ensuring efficient, safe and sound derivatives markets”. 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 25 September.
“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,” says Charlie McCreevy, internal market and services commissioner.
“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.”
L.D.