Credit default swaps could be regulated in future by multiple agencies, including the Federal Reserve, the Commodities Futures Trading Commission and the Securities and Exchange Commission, New York Insurance Superintendent Eric Dinallo said Friday.
“I think if you have two or three or four adequately capitalized regulated exchanges … that’d be fine,” Dinallo said during an interview.
Credit default swaps are unregulated derivative products that have been blamed for spreading the risk of bad mortgages and weakening the global financial system. The swaps are used to protect against a borrower defaulting on its debt or to speculate on borrowers’ credit quality.
Government regulatory agencies and exchanges are currently working on creating a central clearing infrastructure for this market, which has been estimated to be worth about $47 trillion.
The Federal Reserve oversees the Intercontinental Exchange, or ICE, while the CFTC oversees the Chicago Mercantile Exchange, or CME, both of which are interested in being clearinghouses for the market.
“You could have ICE and CME kind of co-existing, but I think it’s important for us to see how that plays out and not cause a potentially rupturing extra situation,” Dinallo said.
Earlier this year, Dinallo said he would hold off on putting in place a plan to begin regulating the about 20 percent of the CDS market that could be classified as insurance products.
“I think the players in this like the Federal Reserve and the SEC and the CFTC all believe they will to some extent all regulate these kinds of exchanges,” Dinallo said.
The SEC “view is that if you are traded on an exchange under an exchange act then they have jurisdiction,” he explained.
“Between those three, I think we’re going to have pretty robust oversight,” Dinallo said.
Dinallo said that, if the clearinghouses require investors to put up a substantial amount of collateral behind the credit default swaps, the vast majority of the remaining 80 percent of the CDS market where there is no ownership of the underlying asset would disappear.
“If the capitalization is correct, you will first of all wipe out a large number of naked credit default swaps because they only work if they are cheap, really cheap,” Dinallo said after speaking at a securities industry conference run by Labaton Sucharow.
Creating requirements to attach capital to the CDS’s would make some of the derivatives too expensive to write, he said.
Credit default swaps allowed companies, including American International Group Inc, to take on significant exposure to mortgage and other debt without having enough capital to back the claims.
AIG nearly collapsed after it ran out of cash to meet collateral calls on credit default swaps it sold to guarantee underlying mortgage debt as the U.S. housing crisis deepened.
(Editing by Andre Grenon)
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