Thursday, November 20, 2008

New York State Shelves Plan to Regulate Credit Swaps

(Bloomberg) New York State Insurance Superintendent Eric Dinallo shelved plans to regulate some credit-default swaps because of progress by federal regulators on broader oversight of the market.

New York will delay rules that would have deemed some of the contracts insurance, requiring those selling the derivatives to be licensed, Dinallo’s department said in a statement today. Dealers and investors have contended that imposing such rules on some transactions and not others would undermine the entire market and would drive traders to set up in other states.

“We don’t want a segmented market,” Dinallo told the U.S. House of Representatives Agriculture Committee in Washington. “We always wanted a holistic solution, and it looks like we’re headed to a holistic outcome.”

The Federal Reserve, U.S. Securities and Exchange Commission and Commodity Futures Trading Commission last week signed a memorandum of understanding they said will for the first time provide broad oversight of the market. The regulators are pressing for creation of at least one central counterparty capitalized by dealers and investors that would back trades and absorb losses should one of the firms fail.

Erik Sirri, the SEC’s director of trading and markets, said plans for the entities should be approved by mid-December.

AIG Failure
Dinallo has blamed credit-default swaps for amplifying the financial crisis. Bets using credit-default swaps that were made by American International Group Inc., once the world’s largest insurer, pushed the company to the brink of bankruptcy in September after it was downgraded and couldn’t come up with collateral on more than $440 billion in contracts linked to mortgages and other debt. The New York-based company ceded control to the U.S. government in exchange for a bailout loan.

Credit-default swaps are financial instruments based on bonds and loans that are used to hedge against losses or to speculate on the ability of borrowers to repay debt. They were conceived to protect bondholders against default and pay the buyer face value in exchange for the underlying securities or the cash equivalent should the borrowers fail to adhere to its debt agreements.

Dinallo had proposed rules to take effect in January that would classify the contracts as insurance if they were sold to an investor that also held the underlying bond. The rules, though, wouldn’t have covered credit-default swaps sold to investors that were speculating on a borrower’s creditworthiness without actually owning the bond.

The central counterparty plans and other proposals requiring more disclosure in the market should make it more transparent and address concerns that dealers and investors don’t have the capital to make good on the trades, Dinallo said.

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