Draft bill betrays lack of CDS understanding, writes Adam Glass

In an article entitled "Credit derivatives for hedgers only: another regulatory proposal flies wide of the mark", Linklaters partner Adam Glass writes that the recent draft bill from US House of Representatives Committee on Agriculture seems eerily devoid of any understanding of how the credit default swap market currently works or should work in future. He adds that the "Derivatives markets transparency and accountability act of 2009" is 38 pages long but that only one page of the bill deals with credit derivatives.

Glass notes that there are several difficulties with the bill as currently drafted. First, it would make it illegal for both protection buyers and protection sellers to enter into a credit default swap unless the person would suffer a financial loss if the credit event occurs. This, he says, seems unlikely to have been the intention of the regulators, who were clearly seeking to limit only purchases of credit protection.

More importantly, and assuming that the bill is supposed to relate to protection buyers only, it would back all protection sellers into acting as insurers. Glass notes that the New York insurance department backed away from its proposal to regulate covered credit default swaps as insurance, on the basis that federal regulators were taking effective steps to fill the regulatory void. "Now Congress, perhaps unwittingly, is proposing to make illegal all credit default swaps that are not insurance," he writes.

After noting several other difficulties with the proposed bill, he concludes that it appears to be a careless swipe at regulating a market that the proponents of the legislation don't know much about and aren't interested in mastering.