New York Will Regulate Credit Default Swaps

New York's Insurance Department has issued a Circular (NY Circular Letter No. 2008-19) titled "Best Practices for Financial Guaranty Insurers." It is the first salvo in the state's campaign to regulate credit default swaps (CDS) by classifying them as insurance. Circular 2008-19 replaces a general counsel opinion from 2000 (NY General Counsel Opinion June 16, 2000).

New York's intentions are further illuminated by a press release from Governor Paterson and the testimony of NY Insurance Superintendent Eric Dinallo before the Senate Agriculture Committee. Dinallo focuses on CDS written on other people's securities. He calls such agreements, "a directional bet on a company's credit worthiness," or, as my boss Mark put it, "me buying insurance on your life."

He lays blame for the rise of these products on the Commodity Futures Modernization Act of 2000 (PL 106-554) which exempted many derivatives from state "bucket shop" laws (7 USCA 16(e)(2)). As Dinallo points out, most states outlawed derivatives in the early 20th Century. New York's anti-bucket shop law (of 1909!), for instance, forbids agreements that are, "settled ... upon the basis of the public market quotations of or prices made on any ... exchange or market upon which such commodities or securities are dealt ... without intending a bona fide purchase or sale of the same," (NY GEN BUS § 351).