Dodd-Frank Swaps: Some Roads Lead to the CFTC

Insurers and insurer groups have sent a number of delegations to talk to Commodity Futures Trading Commission (CFTC) officials about implementing the new swaps rules.

Congress created the swaps rules in the Dodd-Frank Wall Street Reform and Consumer Protection Act because of a concern that unregulated use of swaps had contributed to the 2008 financial crisis by exposing swaps participants to tens of billions of dollars in unexpected collateral calls and trillions of dollars in theoretical exposure to default risk. Dodd-Frank compass

In the act, Congress defines a "swap" as any agreement that is a "put, call, cap, floor, collar, or similar option of any kind that is for the purchase or sale, or based on the value, of one or more interest or other rates, currencies, commodities, securities, instruments of indebtedness, indices, quantitative measures, or other financial or economic interests or property of any kind."

Congress also has created a definition for "security-based swap," which includes any swap that incorporates a security; calls for the CFTC to oversee the swaps market together with the U.S. Securities and Exchange Commission (SEC); and requires many swaps users to conduct deals through exchanges or clearinghouses, rather than conducting the deals "over the counter."

The CFTC has been drafting regulations that would apply to interest rate swaps and currency swaps as well as to swaps involving physical commodities, and it appears that many insurers that have never taken an interest in wheat or gold futures will be running into the CFTC more often.

The CFTC has been posting a log of Dodd-Frank Act-related meetings, and the log shows that insurers, insurance groups and insurance regulators have taken a keen interest in the CFTC.

Representatives from the National Association of Insurance Commissioners (NAIC), Kansas City, Mo., met with CFTC officials about the swaps rule definitions Sept. 1, Sept. 29, Oct. 5 and Monday.

The Consumer Federation of America, Washington, visited Sept. 23, and pension plans and pension plan sponsors called Sept. 17.

Several insurers visited the CFTC with a group of large financial institutions Oct. 6. That group included representatives from American International Group Inc., New York (NYSE:AIG); MetLife Inc., New York (NYSE:MET); and Prudential Financial Inc., Newark, N.J. (NYSE:PRU).

On Nov. 6, representatives from 6 insurers and the American Council of Life Insurers (ACLI),

Washington, visited. MetLife later sent 3 executives back to the CFTC to talk more about the swaps definitions and other Dodd-Frank matters Nov. 12.

When the ACLI visited, it delivered a Dodd-Frank terminology position paper.

"Life insurers are significant end-users of derivative instruments that are used to prudently manage the risks of their assets and liabilities, as permitted under state insurance codes and regulations," the ACLI says in the position paper. "Life insurers' financial products protect millions of individuals, families, and businesses through guaranteed lifetime income, life insurance, long-term care, and disability income insurance. The long-term nature of these products requires insurers to match long-term obligations with assets of a longer duration than most other financial institutions. Derivatives allow life insurers to prudently manage the credit and market risk of their portfolios and to fulfill their obligations to policy and contract owners. The regulatory status of derivatives, therefore, is critically important to the life insurance industry."

The ACLI says Dodd-Frank regulations should reflect the intent of Congress to keep swaps used to manage commercial risk out of the tests used to identify systemically risky swaps users, such as "highly leveraged" swaps users that have borrowed heavily to finance their swaps operations.

"Quantitative thresholds established for determining what is a 'substantial position' and what constitutes 'substantial counterparty risk' should therefore be at levels at which such systemic risk is likely to be present as the result of the bankruptcy or failure to perform of a market end-user, taking into consideration the risk mitigation benefits of netting, collateral, and clearing," the ACLI says.

In a section on the definition of "commercial risk," the ACLI says the term "should be construed to include risks of financial as well as non-financial end-users of derivatives."

The definition of "highly leveraged" should reflect the nature of an entity's business model and financial market sector, to avoid overly simplistic tests and unintended consequences, the ACLI says.

Regulators also should make it very clear that an insurance product is not a swap, the ACLI says.

Dodd-Frank Swaps: Some Roads Lead to the CFTC

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