NCOIL Takes Up CDS In Draft Model Act

NU Online News Service, July 24, 10:39 p.m. EDT

National Conference of Insurance Legislators (NCOIL) leaders said they are working on a model act to protect consumers from "the widespread economic fallout of controversial CDS (credit default swap) transactions."

The NCOIL legislators sent a letter explaining the draft model to the chairs of the U.S. Senate Committees on Banking, Housing and Urban Affairs; and Agriculture, Nutrition and Forestry; as well as the chairs of the House Committees on Financial Services, and Agriculture.

The letter states the draft model would regulate certain "covered" CDS–defined as "those that maintain a material interest in an underlying asset"–as a new form of insurance called credit default insurance (CDI). It would also prohibit "naked" CDS–defined as "swaps in which a party has no material interest in the underlying asset."

The model act would "mandate licensing of credit default insurers and impose solvency standards, such as minimum capital and surplus, as well as contingency, loss, and unearned premium reserve requirements on such insurers," according to the letter.

Specifically, the letter states that the draft model bill would, among other things, require strict limitations on permissible credit default insurance, set single and aggregate risk limits, and authorize minimum policy and rate standards.

"We also included a section that would impose civil and criminal penalties for impermissible credit default insurance," NCOIL legislators said in the letter.

They added that the draft model bill mirrors financial requirements imposed on financial guaranty insurance, which NCOIL said is "a similar credit default instrument."

According to the letter, "Instead of reinventing the wheel, NCOIL Task Force [on CDS Regulation] members based the model bill on New York State Article 69–the 1989 law governing financial guaranty insurance–and drew into its scope the CDS that most resembles insurance."

NCOIL president State Sen. James Seward, R-N.Y., said, "As Congress grapples with how to address an under-regulated market, we feel it essential to alert federal lawmakers of the progress we have made to protect consumers from the widespread economic fallout of controversial CDS transactions. The premise of our draft model act–that credit default swaps with material interest are insurance–means consumers would be protected by the safeguards inherent in state-regulated coverage."