The New York Insurance Department will begin regulating part of the $62 trillion market for credit-default swaps in January, Gov. David Paterson said in announcement yesterday.
Under the new guidelines, a CDS will be considered an insurance contract if the investor owns the underlying security on which it's purchased. "Naked swaps" - in which the underlying asset is not owned - are not considered insurance and will not be regulated.
"The absence of regulatory oversight is the principle cause of the Wall Street meltdown we are currently witnessing," Paterson said. "While I applaud the recent federal intervention to stabilize the market - and thus our entire economy - it is important we also take the next step as a nation by regulating areas of the market which have previously lacked appropriate oversight."
The regulations will not apply to any existing contracts. Many bond insurers hurt their financial position because of these contracts, but very few are now being sold, the department said.
In addition, the department released new best practice guidelines for the bond insurance industry. They will "strictly limit" financial guarantors from guaranteeing collateralized debt obligations of mortgage-backed securities, institute a number of new risk controls, and raise minimum capital and reserve requirements.