NY To Regulate CDS Market, Paterson Urges Fed To Do The Same

September 23, 2008

New York Governor David Paterson said yesterday the state of New York will begin regulating the credit default swaps market on Jan. 1 and that the federal government should follow suit.

With credit default swaps, the buyer pays the seller periodically in exchange for insurance if a company defaults on its debt.

The $62 trillion market for these instruments has gone mostly unregulated since its inception a decade ago. The New York state regulations will affect only about 20% of the entire CDS market.

Paterson’s office has said the goal of these rules is to ensure that sellers have sufficient capital and risk management policies in place to protect buyers. The new rules are aimed at cases where the swap buyer also owns the underlying bond it’s meant to back.

The regulations, which will be enforced through the New York State Insurance Department, would strictly limit financial guarantee insurers from guaranteeing collateralized debt obligations; force insurers to clearly define the risk concentrations; require written risk control and underwriting policies; increase the minimum amount of capital and reserves financial guarantee insurers must maintain; and expand reporting requirements.

These regulations come a year after the state introduced three best-practices rules to address the growing concern surrounding the CDS market. That plan encouraged insurers to work together with other well-capitalized insurers, help financially distressed bond insurers to develop workable solutions and develop new standards for the overall financial guarantee business.

So-called naked swaps, which are bought by speculators who don’t own the underlying bond, cannot be regulated by the state.