The EU will have to win the support of leading emerging economies if it wants to achieve a global reform of the so-called Credit Default Swap (CDS), a senior official from the G20 Presidency told Europolitics.South Korea, which chairs the G20 this year, as well as China and India do not see this issue as a top priority and have so far shown little appetite for an ambitious crackdown on CDS, as proposed by the EU.

These complex financial derivatives products are accused of having worsened the Greek financial crisis and have become the new target of EU financial regulators (see separate article). However, any meaningful and effective reform will require the support of the G20. EU leaders will have to show political resolve in order to convince their G20 colleagues to address this issue during the upcoming summits scheduled for June in Toronto and November in Seoul.

«This issue is becoming highly political and the EU would like to raise it at the summit,» said Shin Hyun Song, representative of the G20 Presidential Committee of South Korea in Seoul. The CDS were not specifically addressed during the previous summit in Pittsburgh and therefore the EU will need to make an extra effort to bring this issue to the fore. If it manages to generate political momentum at ministerial and leaders level then the real battle will take place at the Financial Stability Board (FSB), which is in charge of implementing the G20 financial reform agenda. This is where the action takes place and where the EU needs to raise its voice. A key FSB meeting is scheduled in October ahead of the summit in Seoul.

1. Why the EU needs the G20 to reform effectively CDS?

Private financial institutions around the globe use CDS. In a nutshell, they are contracts that insure debt. Sellers of CDS agree to pay the buyers if the debt goes bad. Through swaps, investors who lend to countries such as Greece by buying their bonds can reduce their risk (see separate article). Hence, supporters of such products argue that without them Greece’s borrowing costs would escalate because lenders would demand higher premiums. The EU, which holds these derivatives responsible for the market speculation that has hit Athens and the euro over the past few weeks, challenges this view. The EU wants to impose strict regulation on the use of CDS but is well aware that only the support of other major global financial actors will make its effort effective. A reform limited to the EU would have only little effect. The support of the US is essential since it is home to key private financial institutions (see separate article) but is not enough. Any effective crackdown on CDS will require the support of the G20 process, which has emerged as the key world economic governance forum in the aftermath of the global financial crisis. A reform without the support of the world’s 20 biggest economies, which account for 85% of the global GDP, would be meaningless.

2. What has the G20 achieved so far in terms of regulating derivatives?

During their three summits in Washington DC (November 2008), London (April 2009) and Pittsburgh (September 2009), G20 leaders committed to «turn the page on an era of irresponsibility and to adopt a set of policies, regulations and reforms to meet the needs of the 21st century global economy». It includes an ambitious reform agenda aimed at regulating financial markets, including financial derivatives products, such as hedge funds or CDS. In Pittsburgh, the G20 promised to «improve the over-the-counter derivatives market and to create more powerful tools to hold large global firms to account for the risks they take». The main objective is to increase the transparency of these transactions through the establishment of a centralised clearinghouse for over-the-counter derivatives, including CDS, as proposed by the London summit. The setting up of such a global framework is under way and should be achieved by mid-2012. The FSB, based in Basel, is in charge of monitoring the implementation of this reform.

3. Is the EU satisfied with what was achieved at the G20 level?

Not entirely. The EU wants to go beyond the concept of a clearinghouse. The de Larosière report, issued by the EU’s high-level working group on financial supervision in February 2009, asked not only for European clearing but also for a more comprehensive risk management and warning system in a highly coordinated institutional framework. «This model introduces a centralised body that acts as counterpart in each transaction,» said Chiara Oldani, professor of economics at the University of Viterbo. Such a highly coordinated mechanism does not go down well with many G20 members who are afraid of over-regulating financial markets.

4. Are other G20 members ready to support the EU’s fresh call for a crackdown on CDS?

The Greek crisis has only heightened the EU appetite for global regulatory reform. This could further increase the gap between Europe and its key negotiating partners within the G20. The US is seen as a key obstacle by the Europeans (see separate article). However, the other big players in the room, namely the emerging economies, will play a growing role in the negotiation this year but they have expressed only little interest in the EU proposal. The main reason is that CDS are used less on emerging financial markets. «It is an advanced market issue. Not a major one for emerging economies,» said Shin Hyun-song. However, South Korea, chair of the G20, is open to put this issue on the agenda. «We are sympathetic to the Europeans. We also faced a major financial crisis in the past (1997),» added the South Korean senior official.