The Corporate Governance of Central Counterparties and Shareholder Primacy: a Re-Evaluation in the Presence of Systemic Risk

Abstract

Amidst the catastrophic collapse of Lehman Brothers in September 2008, central counterparties (‘CCPs’) worldwide kept the global securities and derivatives exchanges afloat by rescuing trillions of dollars of trades affected by the bankruptcy. The successful performance of CCPs during the crisis has put them on the regulatory agenda as new financial bulwark against systemic contagion in the over-the-counter (‘OTC’) derivatives market. By guaranteeing the OTC derivatives of a failing institution, the CCP can supposedly prevent the failure of one institution from spreading to its counterparties. In the EU, the European Market Infrastructure Regulation (‘EMIR’) introduced mandatory clearing via CCPs for certain standardised OTC derivatives. However, the centralisation of risks also makes CCPs central nodes in the financial market, whose failure could have devastating consequences for systemic stability. It is therefore essential from a systemic risk perspective that CCPs correctly manage their risk exposure. This lays bare the weakness of the new system: CCPs are in essence private institutions established for furthering the interests of private parties, not the interests of the prudential regulator. The governance challenge in CCPs therefore lies in ensuring that managers take decisions that safeguard their long-term financial stability. This paper contributes to the debate regarding the governance of CCPs by re-evaluating the appropriateness of the predominant view in Anglo-American corporate governance scholarship that a firm should be run in the interests of its shareholders. In particular, the paper argues that CCPs focused on generating revenue for their shareholders do not have the best incentives to prevent systemic risk generated by their activities. This observation has important implications for the design of the governance of CCPs and in particular requires a re-evaluation of the focus on shareholder value maximisation. The paper shows that the current EU regulatory framework fails to deliver in this respect.