SEC Action Allows Central Counterparty for Credit Default Swaps

The SEC approved temporary exemptions allowing LCH.Clearnet Ltd. to operate as a central counterparty for credit default swaps. The Commission acted to reduce counterparty risk and promote efficiency in the credit default swap market.

Credit default swaps are derivative contracts between two counterparties. Under these agreements, the buyer makes periodic payments to the seller, and will be paid by the seller if the underlying financial instrument goes into default. These instruments trade in a largely unregulated environment worth several trillion dollars. The use of credit default swaps was a key part of the collapse of Lehman Brothers and the turmoil at AIG.

The implementation of central counterparty services for credit default swaps was a top priority of the President's Working Group on Financial Markets. The temporary exemptions will facilitate central counterparties such as LCH.Clearnet and certain of their participants to implement centralized clearing quickly, while providing the Commission time to review their operations and evaluate whether registrations or permanent exemptions should be granted in the future. The conditions to the exemptions are designed to provide that key investor protections and important elements of Commission oversight apply, while taking into account that applying all the particulars of the securities laws could have the unintended consequence of deterring the prompt establishment and use of a central counterparty.

The SEC is seeking public comment on this issue, and did not specify how long the temporary exemptions would remain in force.