Latin American Capital Markets

DESIGNING A DERIVATIVES COMPLEMENT TO CASH MARKETS 357Legal CertaintyOrdinarily, derivatives markets permit trading of contracts representing a potentialproperty interest in an underlying asset, anonymous transacting, and leverage by substitutinga common counterparty for individual counterparties. 26 Legal support forsuch arrangements ordinarily is necessary. Such support reinforces confidence in thereliable and continuous functioning of the market and credit enhancement features,which are crucial for anonymous transacting and sound clearing arrangements forleveraged risk transfer contracts. 27The desirable legal framework includes laws of general application (regardingproperty, contracts, torts, general commercial law, banking, and insolvency) and lawsof special application specifically directed to the operation of the market (laws andregulations regarding the legal relationships between customers, brokers, exchanges,clearing corporations, and settlement banks; the property and contractual rights andinterests held through the market; and the insolvency of a market participant). 28 Asthese markets depend on the rules and contract terms of the product, regulation orlegislation should support certainty that these terms, contractual arrangements, andrules are enforceable.The legal framework should do the following:• Protect the claims of users to the value of their positions, related deliveryrights, and the conclusion of transactions• Include provisions that address and support the property rights to or interestsin margins posted with the market, market positions, and the accruedvalue of positions taken (until disbursed or offset) by market users, brokers,and the clearinghouse or common counterparty, including provisions that addressthe credit enhancer's collateral interest in cash or securities posted asmargin, the disposition of margin in the event of a participant's default, andthe relative priority of the clearinghouse (which represents the market) andother claimants, such as market participants and third parties26 Portions of this section on legal certainty and the following on transparency have been adapted to address developmentissues with permission from Corcoran (2002).27 Markets whose business is interrupted for financial reasons (such as the Hang Seng Index in 1987 in Hong Kong,and the default in the New Zealand market in 1986) or market abuse (London Fox in 1994) may take several yearsto recover28 For a general list of types of laws critical to a robust framework for the successful operation of securities markets,seelOSCO(!998,2002b).Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub