Maybe I’ve spent too many months of reading regulatory proposals and legislation, or maybe I’ve just grown pessimistic, but it seems a credit default swap loophole exists in the otherwise mundane definition of “swap” released by the Commodity Futures Trading Commission on April 27.
The CFTC fact sheet on the proposal tells us that consumer and commercial transactions, loan participations, some forwards and insurance contracts are not swaps. That makes sense. But reading into the definition of insurance made me stop and think – if you take out point four (below), doesn’t this sound very much like a covered credit default swap (CDS)? My comments in parentheses:
- (Must own the bond.) The beneficiary must have an insurable interest that is the subject of the contract and thereby bear the risk of loss with respect to that interest continuously throughout the duration of the contract;
(The underlying has a credit event.) The loss must occur and be proved;
(the notional of the bonds held) any payment or indemnification for loss must be limited to the value of the insurable interest;
- (I’ll get back to this one.) The contract must not be traded, separately from the insured interest, on an organized market or over-the-counter; and
- (Contract terms are up to the dealer.) With respect to financial guaranty insurance only, in the event of a payment default or insolvency of the obligor, any acceleration of payments under the policy must be at the sole discretion of the insurer.