COLUMN – RANDY PRIEM | Currently, the governance of how Determination Committees take major decisions on whether credit events took place for single-name credit default swaps is being re-examined. Our regulatory expert Randy Priem argues that CCPs should have more power.
Randy will also be a speaker with PostTrade 360° Nordic on 4–5 September, in this panel on CCP recovery and resolution. Secure your free ticket for Stockholm today, here!
A single-name credit default swap (CDS) is a type of financial derivative that allows two parties to exchange the risk of a borrower, such as a company, bank, or government, defaulting on their debt. In this agreement, the CDS buyer makes periodic payments to the seller until the contract expires. If the borrower defaults, the seller must compensate the buyer. Decisions about whether a default has occurred are made by Determination Committees, which apply to both corporate and sovereign CDSs.
The DCs have been subject to criticism over the last years. That is, these DCs are composed of major market participants who write the rules of the game and are responsible for interpreting and enforcing them. According to some scholars, like Nathaniel Dutt and Dan Awrey, the DCs promote the interest of only a few major participants. Criticism has also been put forward in articles published by risk.net, Reuters, and the Financial Times, where the DCs were even depicted as a ‘secret circle’ in an article published by Bloomberg.
Irrespectively of whether the criticism is true or not, ISDA did launch a review of the structure and governance of the DCs on 14 December 2024 where Linklaters LLP was appointed to conduct an independent assessment and recommend any changes to maintain the integrity of the DCs in changing economic and market conditions. The process for the development of the report involved interviews with market participants and other stakeholders, such as regulators and academics. On 13 May 2024, Linklaters LLP published the report making several recommendations on possible changes. More concretely in terms of conflicts of interests, Linklaters LLP recommends that e.g. a) the DCs should provide for the appointment of up to three independent members with one acting as the chairperson, b) the rules should enhance the minimum requirements on DC members’ compliance procedures, and c) the DCs should be permitted by a simple majority to refer DC questions to an independent panel for a decision. Linklaters further proposes that a separate governance body is established with responsibility for overseeing the operation of the DCs and making changes to the DC rules from time to time. The governance body should be able to appoint independent auditors to audit DC members’ compliance procedures under the DC rules.
As the proposals are currently under public consultation – where Boston Consulting Group has been appointed to oversee the consultation process – this column argues that another recommendation should be further examined, namely whether the CCPs in the determination committees (i.e. currenly ICE Clear Credit LLC and LCH.Clearnet SA), which now only have observer roles, should get voting rights.
Nowadays, the DC can only use publicly available information in deciding whether to accept a credit event request but CCPs could have more information about a clearing member’s financial condition, as well as in a faster manner, compared to the DCs. The primary role of CCPs is to act as intermediaries in clearing trades and managing counterparty risk. As their expertise lies in risk management and operational processing, they are also market participants being involved in the CDS business. Their risk management insights could be valuable in assessing credit events and the potential impact on the market. Because they typically ‘pass through’ variation margins and not take a directional exposure due to the novation process, they could be considered as more independent than buyers and sellers. Their involvement in the voting could thus contribute to a more robust and resilient decision-making process.
As a senior official of Belgium’s supervisory market authority and member of CPMI-IOSCO’s steering committee, as well as a scholar, Randy Priem continuously monitors the global financial-stability and investor-protection landscape from the very top of the hill. His PostTrade 360° column lets him share informal observations and reflections underway, on subtopics big or small.
Any views expressed are Randy’s personal, not representing positions of his institutions.
