The Circular Letter purports to regulate financial guaranty exposures to asset-backed securities and collateralized debt obligation exposures, including banks and other market participants.

The Governor of New York stated on September 22, 2008 that the state's insurance regulators would start regulating a portion of the credit default swap (CDS) market as insurance. The press release followed the New York State Insurance Department's efforts earlier in 2008 to implement financial guaranty insurance legislation and comes on the heels of the release of Circular Letter No. 19 (2008) dated September 12, 2008.

The Circular Letter purports to extend insurance regulation by requiring that financial guarantors (FGs) that are subject to Article 69 of the New York Insurance Laws, including credit protection sellers, adhere to certain practices (including enhanced capital and surplus requirements, limiting their single risk exposures, etc.). More importantly, the Circular Letter addresses seemingly historical exposures to asset-backed securities (ABS), including collateralized debt obligation (CDO) exposures. The Circular Letter includes the following key points:

  • The Department re-characterizes CDSs as insurance if the credit protection buyer owns the "underlying bond." The Circular Letter does not address whether the analysis applies if the reference credit is something other than a bond (e.g., an index of securities). However, there are significant implications if the CDS is insurance, particularly in an insolvency context, including whether the protection buyer has a claim at all.
  • Under the Department's view, many credit protection sellers, including banks and other CDS market participants, will be regulated as insurers under Article 69 of the Insurance Laws and will need to be licensed as such. Parties that engage only in transactions in which the protection buyer does not own the bond would appear to be outside of the insurance umbrella.
  • The Department restricts the issuance of financial guaranty policies that support CDOs of ABS and states, for what seems to be the first time, that financial guaranties can support "pools" as long as the "pools" do not include ABS "that are collateralized by successive pools of ABS so as to create several tranches of securitizations."
  • The Department revises the permissible termination and credit events that may trigger payment or acceleration under a financial guaranty policy and, arguably, under a CDS in order to "preclude the possibility that CDS counterparties will present claims ahead of other insured parties."

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