Central Counterparties in the OTC Derivatives Market from the Perspective of the Legal Theory of Finance, Financial Market Stability and the Public Good

Abstract

In light of the recent global financial crisis, regulatory attention has been focused on the Janus-headed activity of over-the-counter (OTC) credit derivatives. As a result, heavy-handed measures have been introduced, such as those in the Dodd–Frank Act and the European market infrastructure regulation, which mandate central counterparty clearing for OTC credit derivatives. The deployment of central counterparties (CCPs) is by no means a panacea for global financial stability. Drawing on the ongoing debate about the benefits of CCPs, this paper considers them through the lens of the Legal Theory of Finance proposed by Katharina Pistor. This leads to a number of observations: firstly, CCPs lack sufficient tools to adjust for the materialisation of unexpected circumstances, not least because of precarious state-contingent collateral calls. Moreover, the hierarchy of the financial system highlights a hierarchy with respect to the vindication of property rights in times of crisis. This causes one to consider financial stability as a public good and to argue in favour of stronger social responsibility in financial markets. Major financial players ought to be required to have more ‘skin in the game’. CCPs therefore lend themselves as a focal point for regulatory measures.