NCOIL Urges Congress, Let States Regulate Credit Swaps

WASHINGTON--A New York state legislator representing the National Conference of Insurance Legislators called on Congress yesterday to allow states to regulate credit default swaps, saying they are a "species of insurance" and "best left to the regulatory purview of the states."

The comments by New York Assemblyman Joseph Morelle, D-Irondequoit, on behalf of NCOIL took part at a hearing on legislation introduced by Rep. Collin Peterson, D-Minn., chairman of the House Agriculture Committee.

The bill Rep. Peterson is drafting would require most over-the-counter derivatives to be cleared by federally regulated clearinghouses and ban "naked" credit default swaps.

In his testimony, Mr. Morelle said that "Frankly, this discussion is not only appropriate but, perhaps, sadly overdue.

"It is a discussion with implications beyond even the very broad horizons of its specific subject matter, for it relates to our fundamental notions of the free market system," he said.

He added that if Congress concludes that CDS "are a species of insurance, and I would strongly suggest that they are, then authority in relation to CDS must accrue to the states."

Mr. Morelle said that it is NCOIL's position, "that state regulators, with their extensive experience at regulating insurance products, are extremely qualified to regulate covered CDS as insurance products."

He also said that it is NCOIL's position that Congress erred when it preempted the states from regulating CDS "under our gaming and bucket shop laws" when it passed the Commodities Futures Modernization Act of 2000.

He said the act "permitted so-called 'naked swaps'--those CDS contracts that are speculative in nature and are merely directional bets on market outcomes--to proliferate to the point where they now constitute 80 percent of the CDS market, which has a notional value of around $54 trillion, with no regulatory framework."

Mr. Morelle said the NCOIL Financial Services Committee will discuss the hearing and chart a formal policy course for the organization when it meets Feb. 28, during the upcoming NCOIL Spring Meeting in Washington.

The hearing and the legislation introduced by Rep. Peterson--as well as similar legislation introduced in the Senate Agriculture Committee--represent the opening bell in what is expected to be a knock-out, drag-out fight by legislators of all stripes to win oversight over CDS.

Currently, agricultural committees in the House and Senate oversee the Commodity Futures Exchange Commission, which regulates trading in derivatives for both commodities and financial products.

But, regulation of CDS--or lack of regulation--has become a hot issue. That's because losses by companies that speculated that insuring them would be highly profitable, for example by American International Group and monoline insurers, have cost these companies billions of dollars and threatened their solvency.

Tuesday, for example, at a briefing for reporters, Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, said imposing strong oversight of CDS and other highly speculative financial products would be the top priority for his committee this year.

He proposed that oversight of trading in derivatives of financial products be shifted to his committee from the House Agriculture Committee as just one of several means of ensuring strong oversight of financial services firms who participate in these markets.

What he is proposing, Rep. Frank said, is to leave the House and Senate agricultural committees only to oversee trading in "the edibles," i.e., agricultural commodities, as well as, probably, trading in oil and other natural resources.

Rep. Frank also suggested that a systemic regulator, probably the Federal Reserve Board, which is overseen by his committee, be given authority to monitor companies involved in this industry.