On July 3, 3009, the Commission of the European Communities (the “Commission”) adopted a communication (the “Communication”) on the subject of Ensuring efficient, safe and sound derivatives markets. LINK.
In the Communication, the Commission acknowledged that derivatives are an integral part of the global economy in that “[t]hey share or redistribute risks and they can be used as protection against a particular risk” enabling “commercial entities, such as airline companies, manufacturers, etc. . . . to cover the risk of price increase in the basic materials they use to run their business and to better plan their future needs.” However, the Commission went on to note that, as highlighted by the current financial crisis, the opaqueness of the privately negotiated over-the-counter (“OTC”) derivatives market prevented market participants, supervisors and regulators from assessing and appreciating the risks associated with derivatives, particularly counterparty risk. The Commission pointed out that counterparty risk is particularly acute in connection with credit default swaps (“CDS”) because (i) the credit risk that these contracts cover is difficult to assess, and may come on quite suddenly and (ii) the potential settlement of these contracts is “extreme,” in that a seller of protection must pay the full principal amount of the contract minus the value of the defaulted obligation. READ MORE →