Much has been written lately regarding the role of derivatives and, specifically, credit default swaps (CDS), in the current market turmoil. Numerous public officials and regulatory bodies have urged for greater regulation of the CDS market. The most specific recent regulatory proposal with respect to CDS had been that of the State of New York Insurance Department (Insurance Department), which proposed to apply New York Insurance Law to certain CDS. The proposed regulation was to take effect in January 2009 and threatened to require certain sellers of credit protection under CDS to be licensed as insurance providers. The Insurance Department announced its regulatory proposal in Circular Letter No. 19 (2008), dated September 22, 2008 (September Circular).
On November 20, 2008, the Insurance Department published its First Supplement to the September Circular (November Supplement) announcing its decision to “delay indefinitely its application of New York Insurance Law to CDS.” The portion of the September Circular that had addressed best practices for financial guaranty insurers was not modified by the November Supplement.
The November Supplement references the November 14, 2008 statement by the President’s Working Group on Financial Markets (PWG), which included a series of initiatives and policy objectives regarding strengthened oversight and transparency of the CDS market. The PWG also announced that the Federal Reserve Board of Governors, the Securities and Exchange Commission and the Commodity Futures Trading Commission, had entered into a Memorandum of Understanding regarding the regulation of a centralized counterparty for the CDS market. According to the November Supplement, it was “in light of this progress made toward comprehensive federal regulation of CDS” that the Insurance Department determined to delay indefinitely its proposed regulation.
The Insurance Department’s September Circular had met with strong reaction from CDS market participants, their advisers and the International Swaps and Derivatives Association. Many had been quick to note that the September Circular represented a seismic shift in the Insurance Department’s position on the regulation of CDS as insurance. It is a fundamental premise of the CDS market that CDS are not insurance products. This conclusion historically had been supported by the Insurance Department, notably in a June 2000 opinion issued by the Insurance Department’s Office of General Counsel. The September Circular stated that the June 2000 opinion was to be reconsidered. Market participants also had noted that the proposed regulation would only have applied to a portion (likely small) of the overall CDS market, which would have led to a fragmented regulatory regime for the CDS market as a whole.
In his testimony to the House Agriculture Committee on November 20, the State of New York Superintendent of Insurance acknowledged that the “best solution for a healthy market...is a single market.” The press release accompanying the November Supplement set out additional provisions viewed by the Insurance Department as necessary for effective regulation of CDS, including capital adequacy requirements, margin requirements, a guaranty fund to prevent systemic risk caused by the failure of one CDS seller, dispute resolution mechanics, transparency and the collection and availability of comprehensive market data and mandatory regulatory oversight of the market.