Podcast Center
Video Center
Webcasts
Resource Center
Events
October 14, 2008 at 12:06 PM
New York State Insurance Superintendent Eric Dinallo spoke at a hearing here today about coming up with a “holistic” approach to regulating the credit default swaps market.
A credit default swap is an over-the-counter contract that gives the buyer the right to collect a payment from the seller if a borrower defaults on the terms of a bond, note or other debt security.
Dinallo told members of the Senate Agriculture Committee that credit default swaps can be divided into two categories.
The first category includes transactions in which the holder of an obligation, such as a bond, “swaps” the risk of default with another party for a fee.
That type of transaction resembles an insurance transaction, Dinallo said.
The second category of credit default swaps includes “naked credit defaults swaps,” Dinallo said.
When parties set up a naked credit default swap, neither party owns the bond, note or other obligation linked to the swap, Dinallo said.
In effect, Dinallo said, a naked credit default swap is a bet on whether the issuer of the obligation will default.
Dinallo noted that the Commodity Futures Modernization Act, passed in 2000, created a “safe harbor” for credit default swaps.
The CFMA safe harbor preempted state laws that would have barred credit default swaps and exempted credit default swaps from regulation by the Commodity Futures Trading Commission, Dinallo testified.
Also in 2000, someone asked the New York Department of Insurance a “very carefully crafted question” about whether the department would treat naked credit default swaps as insurance contracts.
“Clearly, the question was framed to ask only about naked credit default swaps with no proof of loss,” Dinallo said. “Under the facts we were given, the swap was not ‘a contract of insurance’ because the buyer had no material interest and the filing of a claim does not require a loss. But the entities involved were careful not to ask about covered credit default swaps. Nonetheless, the market took the department’s opinion on a subset of credit default swaps as a ruling on all swaps and, to be fair, the department did nothing to the contrary.”
