Subsidising liquidity or subsidising markets? Safe harbors, derivatives, and finance

In my experience, financial market participants simply would not enter into certain Safe Harbored Contracts without the protection afforded by the safe harbors . . Because of the direct and dramatic effect that eliminating or substantially narrowing the safe harbors would have on markets for Safe Harbored Contracts, a decision to proceed with such revisions equates to a determination that these marķēts do not provide value to the financial system or the broader economy and thus can be curtailed or eliminated.5 In short, the safe harbors created the derivatives markets, and without the safe harbors the markets would disappear or massively shrink.6 Whether the repeal or narrowing of the safe harbors would represent the judgment expressed in the highlighted section, or would instead represent other judg' ments - such as a belief that the derivatives market should play by the same basic rules as other financial markets, or that the costs of the safe harbors outweigh the value of the markets created thereby7 - is unclear. [...]Professor Paech argues that the safe harbors increase the efficient use of regulatory capital, because banks are allowed to calculate their capital on the basis of net, rather than gross, credit risk exposures.61 The secured credit-like nature of the safe harbors again raises the issue of cost. [...]one might question how much practical relevance the continental European jurisdictions have to the global derivatives markets, given the comparatively small number of trades occurring within these jurisdictions. [...]for every jurisdiction like Belgium that Professor Paech points to, a critic of the safe harbors can point to a jurisdiction like Canada where secured creditors are subject to the stay imposed in Companies' Creditors Arrangement Act proceedings.67 For every Germany, there is a Japan.68 More generally, there is the question of what liquidity means in the derivatives context. According to securities dealers, their hope is that the bankruptcy court's treatment of repos between Lombard-Wall and Dauphine will not be widely viewed as a precedent. 1 Judge Ryan's law clerk said yesterday that the judge intended to prepare a written decision on the Dauphine repos but not until he has received comments from interested parties.