Clearing Credit Default Swaps: A Case Study in Global Legal Convergence

47 Pages Posted: 27 Mar 2010 Last revised: 8 Apr 2010

Anupam Chander

University of California, Davis - School of Law

Randall Costa

affiliation not provided to SSRN

Date Written: March 22, 2010


In the wake of the global financial crisis, American and European regulators quickly converged on a reform intended to help stave off similar crises in the future: central counterparty clearinghouses for credit default swaps. On both sides of the Atlantic, regulators identified credit default swaps (CDS) as a central factor in the crisis that seized Bear Stearns, Lehman Brothers, American International Group (AIG), and ultimately global credit markets. Introducing a well-capitalized central counterparty between CDS buyers and sellers would, regulators came to believe, help contain financial failures in the future.

How and why did this convergence occur? This Article reviews the American and European responses, concluding that they converged on a similar structure largely because the financial crisis revealed the vulnerabilities of a system in which buyers and sellers entered into CDS directly, through bilateral contracts. These bilateral derivatives contracts created a web of interconnected obligations, such that the failure of one firm could bring down a chain of others. The threat of this domino effect led governments to intervene in the financial markets with massive direct and indirect support. Forced to spend public money to bail out private firms, regulators risked an unsustainable moral hazard - firms that were “Too Interconnected to Fail.” Regulators concluded that the introduction of a central counterparty (CCP) would reduce the risk that the bankruptcy of a principal in a credit default swap would precipitate a domino fall through the credit markets. Where critics argue that CCPs concentrate risk, regulators came to recognize that Bear, Lehman, and AIG had each also concentrated risk, serving as de facto central clearing counterparties, lacking the disciplines of a regulated CCP.

Keywords: Credit default swaps, credit derivatives, Bear Stearns, Lehman Brothers, global convergence, too big to fail, central counterparty clearing

Suggested Citation

Chander, Anupam and Costa, Randall, Clearing Credit Default Swaps: A Case Study in Global Legal Convergence (March 22, 2010). Chicago Journal of International Law, Vol. 10, No. 639, 2010; UC Davis Legal Studies Research Paper No. 211. Available at SSRN:

Anupam Chander (Contact Author)

University of California, Davis - School of Law ( email )

400 Mrak Hall Drive
Davis, CA 95616-5201
United States
530-754-5304 (Phone)
530-754-5311 (Fax)

Randall Costa

affiliation not provided to SSRN ( email )

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