Market formation and governance in international financial markets: The case of OTC derivatives¹

How are markets developed and governed? The article reviews four perspectives on the formation and development of markets and market governance — the political perspective (Fligstein), the network perspective (White), the framing perspective (Callon) and the soft law/expert power perspective (Slaughter). It then utilizes these perspectives in order to understand the development of the market for over-the-counter (OTC) derivatives. It finds that this market was stabilized and governed through the operation of all of these features — power, networks, framing and expert power. The International Swaps and Dealers Association (ISDA) to which all market participants belong has played a central role in this process. It has created a Master Agreement that is the common basis to all OTC derivative contracts across the world and seeks to overcome potentially problematic areas such as netting and collateral. It brings together all market participants and uses their expertise within its committees to develop new rules. However, the article shows that ISDA as a private international association cannot sustain governance by itself. It has to influence national governments in order to ensure that its Master Agreement is enforceable even though the agreement favours ISDA members above other actors. This has the potential for political controversy though mainly governments deal with it as an issue of technical expertise. At the public, international level, the central bankers forum in Basle is also concerned with the oversight of the sector and have issued a number of warnings about potential sources of instability arising from the derivatives market. The article illustrates that the market formation process is highly complex and that the governance of the market is multi-levelled and precarious. The research raises questions about how other complex markets are being created and how their governance structures are determined.