Party Autonomy in International Property Law - Peace Palace Library

11. Financial Collateral Arrangements and Party Autonomy
made regardless of whether the payee has suffered a loss, which of course
is not true for insurance contracts. 7
Credit default swaps are used for many purposes. The protection buyer
might want to hedge an actual credit risk (because it is holding bonds in
a company but is not willing to bear this risk). It may also enter into the
credit default swap for purely speculative reasons. We have already seen
that there is no legal requirement for the protection buyer to have an
actual insurable risk; anyone can purchase credit protection in relation to
a specified reference entity. This is another key difference between credit
default swaps and insurance contracts. It is not possible for me to take out
insurance on my neighbour’s house; I need to have an insurable interest
in order to be able to obtain insurance. However, by entering into a credit
default swap, I can insure against a risk that I did not run in the first place,
which might give rise to perverse incentives because I may now have an
interest in the reference entity going bust. This is one of the failings of
credit default swaps which became increasingly apparent following the
credit crisis. 8 On the other hand, as we have just observed, payments must
be made under the credit default swap irrespective of whether there was
an actual loss. This then is the main argument for not classifying these
types of products as insurance contracts. 9
The amounts involved in the credit default swap markets are truly mindboggling.
The Bank for International Settlements publishes statistics on
a regular basis and these show that the notional amounts outstanding 10
7
Hudson 2009, § 43-54.
8
Hershey H. Friedman and Linda W. Friedman, ‘The Global Financial Crisis of
2008: What Went Wrong?’, available at ssrn.com / ​abstract=1356193, pp. 14
& 15.
9
Hudson 2009, § 43-54.
10
The following description of this measure was taken from p. 3 of the Bank of
International Settlements’ report on OTC Derivatives markets of November
2009, available at http: // ​www.bis.org / ​publ / ​otc_hy0911.pdf?noframes=1:
‘Nominal or notional amounts outstanding provide a measure of market size
and a reference from which contractual payments are determined in derivatives
markets. However, such amounts are generally not those truly at risk.
The amounts at risk in derivatives contracts are a function of the price level
and / ​or volatility of the financial reference index used in the determination of
contract payments, the duration and liquidity of contracts, and the creditworthiness
of counterparties. They are also a function of whether an exchange of
Reinout M. Wibier
229
© sellier. european law publishers
www.sellier.de