Party Autonomy in International Property Law - Peace Palace Library

11. Financial Collateral Arrangements and Party Autonomy
I am not going to discuss these issues, although they are of course of great
importance. But one thing it is worth noting is that the credit crisis has
also shown is that having the protection of a credit default swap is only
helpful if your counterparty, the protection seller, is able to make good on
her promise to pay up if a credit event occurs. Of the various mechanisms
that are used in order to mitigate this counterparty risk, a number of which
are listed below, the provision of financial collateral – the subject matter
of this chapter – is only one. These risk reduction instruments include:
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Payment netting and close-out netting: reducing exposures by agreeing
that there will only be one net payment due between parties that
have entered into numerous contracts with differing payment obligations.
Netting involves the cancellation of all outstanding contracts
followed by the setting off of all amounts due so that one net payment
remains. Netting thus reduces the number of payment obligations and
amounts involved;
Further hedging: entering into a matching transaction (e.g. a credit
default swap) with a different party in order to cover the risk of the
counterparty’s non-performance in the original transaction.
Providing financial collateral for the amounts due under a financial
contract: transferring collateral or providing a security interest over
collateral in order to cover the outstanding payment obligations.
The last of these risk reduction instruments – the providing of financial
collateral – is the subject matter of the remainder of this chapter.
That the provision of financial collateral will continue to play an important
role, notwithstanding the fact that credit default swaps are subject
to a lot of scrutiny right now and currently seem unlikely to be able to
avoid more stringent regulation, is clear from the recent initiatives of the
EU Commission aimed at improving the derivatives markets. The initiatives
indicate that the Commission is planning to introduce legislation
Clearing and Settlement’, available at ssrn.com / ​abstract=1430576; Stephen
G Cecchetti, Jacob Gyntelberg and Marc Hollanders, ‘Central Counterparties
for over-the-counter derivatives’, available at ssrn.com / ​abstract=1472960;
and Craig Pirrong, The Clearinghouse Cure’, Regulation, Winter 2008-2009,
pp. 44-51.
Reinout M. Wibier
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