Congress should let state officials regulate credit default swaps because they are a "species of insurance," a New York lawmaker speaking for the National Conference of Insurance Legislators contends.
The comments by New York Assemblyman Joseph Morelle, D-Irondequoit, on behalf of NCOIL came during a hearing on a federal bill that would require most over-the-counter derivatives to be overseen by federally regulated clearinghouses, while banning "naked" credit default swaps–traded by those who do not own the underlying security.
If Congress concludes that credit default swaps 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 in his testimony on the bill introduced by Rep. Collin Peterson, D-Minn., chair of the House Agriculture Committee.
It is NCOIL's position, he added, that "state regulators, with their extensive experience at regulating insurance products, are extremely qualified to regulate covered CDS as insurance products."
He also said NCOIL believes Congress made a mistake when it preempted state regulation of credit default swaps "under our gaming and bucket shop laws" when it passed the Commodities Futures Modernization Act of 2000.
He said that law "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 matter and chart a formal policy course for the organization when it meets on Feb. 28, during its quarterly meeting in Washington.
The hearing and the bill 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-down, drag-out fight by legislators of all stripes to win authority over CDS.
Currently, the House and Senate Agriculture Committees oversee the Commodity Futures Exchange Commission, which regulates trading in derivatives for both commodities and financial products.
However, regulation of CDS–or lack thereof–has become a hot issue because companies that traded them to cover collateralized-debt obligations backed by subprime home mortgages–including American International Group's Financial Products unit and monoline insurers–have lost billions, threatening their solvency.
At a recent briefing for reporters, Rep. Barney Frank, D-Mass., who chairs the House Financial Services Committee, said imposing strong CDS oversight and other highly speculative financial products would be the top priority for his committee.
He proposed that oversight of trading in derivatives of financial products be shifted to his panel from the House Agriculture Committee as just one of several means of ensuring stronger regulation of financial services firms participating in these markets.
What he is proposing, Rep. Frank said, is to leave the House and Senate Agriculture Committees only to oversee trading in "the edibles"–agricultural commodities–as well as perhaps 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.
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