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EU approves credit derivatives clearing to increase market stability

A range of credit default swaps will now become the second class of over-the-counter (OTC) derivatives required to be cleared through central counterparties (CCPs) in a bid by the European Commission to stabilise financial markets.03 Mar 2016

CCPs clear transactions between two parties, helping to manage the risk that can arise if one party defaults on its payments. Credit default swaps are the most common type of credit derivatives. By requiring some classes of credit default swaps to be cleared through CCPs, the Commission aims to make financial markets become more stable and less risky, it said.

The announcement follows commitments made by world leaders at the G20 summit in Pittsburgh in 2009, when G20 leaders agreed that standardised OTC derivative contracts should be centrally cleared through CCPs, and implements part of the clearing obligations set out under the European Market Infrastructure Regulation (EMIR), the Commission said.

The Commission has laid out details of the classes of credit default swaps covered by the clearing rules – these comprise euro denominated credit default swaps based on the two main European credit default swap benchmark indices, with a five-year maturity and from a specified series.

A credit default swap index is an index based on a basket of corporate or sovereign entities as opposed to a single-name credit default swap, where the contract relates to the default of a single named entity. There are two main families of indices – CDX, which contain North American and emerging market companies, and iTraxx which contain companies from the rest of the world and sovereign indices covering global markets.         

The proposal has still to be approved by the European Parliament and the Council of the EU, the Commission said. If approved, the regulation will be phased in over several years. The regulation specifies four different categories of counterparty, each with a different phase-in period.

Jonathan Hill, EU commissioner for financial stability, financial services and capital markets union, said: "Today’s decision marks another step towards making good on our G20 commitments to bolster financial stability, reduce risks and boost market confidence."

The first clearing obligation under EMIR, in relation to certain classes of interest rate swaps, was adopted by the Commission in August 2015 and entered into force in December 2015 subject to a phasing-in period.