Regulation of credit default swaps—the Short Selling Regulation
Regulation of credit default swaps—the Short Selling Regulation

The following Financial Services guidance note provides comprehensive and up to date legal information covering:

  • Regulation of credit default swaps—the Short Selling Regulation
  • What is a credit default swap?
  • Why are credit default swaps captured by the short selling regulations?
  • Powers of competent authorities under the Short Selling Regulation

What is a credit default swap?

A CDS is a form of credit derivative agreement, under which the buyer will make regular premium payments to the seller, called the spread. When a buyer and a seller enter into an arrangement they both take on counterparty risk and the spread is used to insure against an event of default otherwise known as a credit event. This is because a CDS is usually linked to a 'reference entity' or 'reference obligor'. This is normally a corporation or government. The reference entity is not a party to the contract but it is the defaulting act of the reference entity that triggers the credit event. In the event of a credit event, the seller of the CDS is required to compensate the buyer of a CDS.

The Short Selling Regulation (EU) 236/2012 (the Short Selling Regulation) identifies two types of CDS:

Article 1(c) defines a credit default swap as:

‘a derivative contract in which one party pays a fee to another party in return for a payment or other benefit in the case of a credit event relating to a reference entity and of any other default, relating to that derivative contract, which has a similar economic effect’.

and art 1(e) states ‘sovereign credit default swap’ means a credit default swap where a payment or other