Trichet: Eurozone CCP will help improve oversight

European Central Bank president Jean-Claude Trichet backed a central counterparty (CCP) for clearing credit default swap (CDS) trades in the eurozone today, in a speech that also called for banker compensation to be linked to avoiding excessive leverage.

Nine major banks agreed to use a European CCP last week, ending a deadlock between the industry and the European Commission. Trichet said a CCP would improve transparency and robustness in the over-the-counter derivatives market, and added that he saw "considerable merit" in having central clearing take place within the eurozone.

While the banks agreed to use a CCP based in the EU, they did not specify whether or not it should also be in the eurozone - leaving the field open for London-based contenders such as NYSE Liffe and LCH.Clearnet's joint initiative and Ice Trust Europe, as well as Eurex, which is based in Frankfurt and has promised to start clearing CDS index trades next month.

Trichet also blamed "excessive short-termism" for much of the current crisis, and said bankers' incentives should be changed to promote a longer-term view. In particular, he said, compensation should be linked to the degree of leverage. "Compensation schemes must be adjusted to avoid encouraging excessive risk-taking on the basis of relatively small amounts of capital," he said.

He also blamed the crisis on the gradual erosion of capital reserves in the name of greater efficiency. "We have to put reserves and buffers back into the system," he remarked. "They are an integral part of sound finance."

Nevertheless, he added that forcing banks to hold more capital would be procyclical, insisting "banks should not be requested to hold more capital than is required by the existing capital framework".

See also: Banks agree to EU CCP for clearing CDS