Private Law and the Public Sector’s Central Counterparty Prescription for the Derivatives Markets

Abstract

In the wake of the financial crisis considerable momentum has built-up behind proposals to extend central counterparty (CCP) clearing in the over-the-counter derivatives markets. However, the implementation of new rules is proving complex. This paper argues that one cause of this complexity is that the public sector is seeking to incorporate into legislation (and require the wider use of) a privately owned and operated risk management mechanism. As a matter of law, the paper argues that CCP clearing can be understood as a market-generated ‘legal device’; in other words, one designed to support the markets by means of the interaction of various private law techniques. Following this analysis through, the paper highlights the benefits and drawbacks which derive from the legal techniques underlying CCP clearing (standardisation of contracts, asset-backing, netting, and so on) and argues that these qualities are inherent to the device. It concludes that the inherent capacity of CCP clearing gives rise to a qualitatively different set of challenges for policymakers than those arising from technical implementation, and it explains that both types of problem need to be addressed if the CCP prescription is to be effective.

Keywords: OTC derivatives, credit default swaps, central counterparty clearing, CCPs, netting, Dodd-Frank Act, regulatory reform