Industry Groups Respond to NCOIL Model Legislation for Regulation of Credit Default Swaps


In a letter dated May 22, 2009 to the Chairman of the Task Force on Credit Default Swaps Regulation of the National Conference of Insurance Legislators (“NCOIL”), ISDA and the Securities Industry and Financial Markets Association (“SIFMA”) commented on NCOIL’s proposed model legislation (the “Model Legislation”) to regulate credit default swaps (“CDS”). NCOIL drafted the Model Legislation based on the provisions of Article 69 of the New York Insurance Law relating to financial guaranty insurance.

SIFMA and ISDA acknowledged that increased regulatory supervision of CDS is needed to reduce systemic risk and increase transparency and liquidity in the markets. However, the groups pointed out that, if the Model Legislation were passed in its present form, it “would adversely affect commercial, industrial, and other companies that benefit from CDS, as well as banks and other financial firms that act as CDS dealers, and might cause financial institutions to move their CDS businesses out of state or offshore. These consequences are likely and they would harm local economies.”

Moreover the groups objected, as a fundamental matter, to CDS contracts being categorized as insurance at all, noting that several characteristics distinguish insurance from CDS contracts, including (i) the fact that insurance requires an insurable interest, whereas CDS contracts are often purchased by parties that are not exposed to or hedging a specific underlying risk, (ii) insurance contracts generally are purchased and continue to be held by the original buyer, whereas CDS contracts are often purchased and sold by the initial purchaser and (iii) insurance only pays out when the insured party actually incurs a loss, whereas CDS contracts simply provide for payment upon the occurrence of a credit event (and the satisfaction of certain specified conditions to settlement).

Finally, SIFMA and ISDA stated that the Model Legislation threatened to undermine the recent proposals by the Obama Administration to establish a comprehensive framework for regulating derivatives. As SIFMA and ISDA noted, the Model Legislation “risks effectively eliminating the domestic CDS market or, at best, creating a patchwork of legislation with state-based variations.”