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In light of progress being made to create central counterparties for credit default swaps with federal oversight, New York will delay for now its plan to regulate some swaps, New York State Insurance Superintendent Eric Dinallo announced in testimony to the House Agriculture Committee today.

In a Circular Letter issued on September 22, New York noted that credit default swaps were unregulated and had played a major role in the current financial crisis. Dinallo announced that New York had determined that some credit default swaps were subject to regulation under state insurance law and that the New York State Insurance Department would begin to regulate them on January 1, 2009. He also called on the federal government to develop a comprehensive solution for regulating the entire market for credit default swaps.

“There is no question that unregulated credit default swaps added fuel to the subprime fire and made the financial crisis we now face worse. Because of the serious problems resulting from the total lack of regulation of credit default swaps and the urgency of reform, New York was prepared to step in, even though we were legally limited to regulating only part of the market. However, the best solution for a healthy market is credit default swaps is a single market. That won’t happen if New York regulates some transactions under the insurance law, while the rest of the market is either unregulated or regulated under other laws. I am pleased to see that our strong stand has encouraged the industry and the federal government to begin developing comprehensive solutions. Accordingly, we will delay indefinitely regulating part of the market,” Dinallo said.

On Friday, November 14, the President’s Working Group on Financial Markets announced a series of initiatives to strengthen oversight and transparency and create a centralized market infrastructure for the over-the-counter derivatives market, including credit default swaps. The initiatives include the development of credit default swap central counterparties, some of which are expected to begin operations before the end of 2008. The Federal Reserve Board of Governors, the Securities and Exchange Commission and the Commodity Futures Trading Commission signed a Memorandum of Understanding regarding the supervision of credit default swap central counterparties

The New York Federal Reserve Bank and the New York Banking Department are working with one of the proposed central counterparties to establish a New York trust company to serve as a clearing house for credit default swaps. Processing this application is a top priority of the Superintendent of Banks and the Banking Department.

“We understand that the market for credit default swaps is large and complex and it will take time to complete a holistic solution. But while we support these beginning efforts, we also recognize that they do not yet constitute a completely transparent and fully regulated market. We urge the industry, federal agencies and Congress to continue working until that essential goal is reached. At that point, we will be prepared to consider any necessary changes in state law to prevent problems that might arise from the fact that some swaps are insurance,” Dinallo said.

Effective regulation of credit default swaps should include the following provisions:

  • All sellers must maintain adequate capital and post sufficient trading margins to minimize counterparty risk.
  • A guaranty fund should be created that ensures that a failure of one seller will not create a cascade of failures in the market.
  • There must be clear and inclusive dispute resolution mechanisms.
  • To ensure transparency and permit monitoring, comprehensive market data should be collected and available.
  • The market must have comprehensive regulatory oversight, and regulation cannot be voluntary.
Testimony By New York State Insurance Superintendent Eric Dinallo To The United States House of Representatives Committee On Agriculture - Hearing To Review The Role Of Credit Derivatives In the US Economy - November 20, 2008



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