S7306A-2011 - NY Senate Open Legislation - Relates to derivative transactions and derivative instruments

Relates to derivative transactions and over the counter derivative instruments.

Sponsor: SEWARD
Law Section: Insurance Law / Law: Amd SS1401 & 1410, Ins L

S7306A-2011 Actions

Jun 20, 2012: SUBSTITUTED BY A10532A
Jun 14, 2012: AMENDED ON THIRD READING 7306B
Jun 6, 2012: ADVANCED TO THIRD READING
Jun 5, 2012: 2ND REPORT CAL.
Jun 4, 2012: 1ST REPORT CAL.998
May 29, 2012: PRINT NUMBER 7306A
May 29, 2012: AMEND AND RECOMMIT TO INSURANCE
May 2, 2012: REFERRED TO INSURANCE

S7306A-2011 Meetings

Insurance: Jun 4, 2012

S7306A-2011 Calendars

Floor Calendar: Jun 5, 2012 , Floor Calendar: Jun 6, 2012 , Floor Calendar: Jun 11, 2012 , Floor Calendar: Jun 12, 2012 , Floor Calendar: Jun 13, 2012 , Floor Calendar: Jun 14, 2012

S7306A-2011 Votes

VOTE: COMMITTEE VOTE: - Insurance - Jun 4, 2012

Ayes (17): Seward, Flanagan, Golden, Grisanti, Lanza, Larkin, LaValle, Martins, Saland, Young, Breslin, Diaz, Espaillat, Kennedy, Parker, Peralta, Stavisky
Excused (1): Smith

S7306A-2011 Memo

BILL NUMBER:S7306A

TITLE OF BILL:
An act
to amend the insurance law, in relation to derivative transactions and
derivative instruments

PURPOSE:
This bill would amend ��1401 and 1410 of the insurance law to
refine the definition of "qualified counterparty" and make other
definitional amendments to the provisions of the law relating to
permissible counterparties with which insurers may enter into
derivative transactions pursuant to the current restrictions in the
insurance law.

These amendments are intended to strengthen the rules applied to
insurer derivative transactions with "qualified counterparties" in
order to ensure that they are fully collateralized pursuant to a
master netting agreement. These amendments will allow insurers to
continue entering into responsible derivatives arrangements to hedge
their investment strategies. These arrangements assist insurers in
supporting their ability to continue to offer certain variable
insurance products to consumers, to keep product pricing affordable
and ensure that they can continue to meet their policyholder
obligations.

SUMMARY OF PROVISIONS:
This bill would amend subsection (a) of section
1401 of the insurance law to add new paragraphs (19) - (21) which
establish new definitions of "over the counter derivative
instrument", "clearinghouse" and "master agreement" to Article 14 of
the insurance law which addresses investment by insurers. This bill
would also amend subsection (f) of section 1410 of the insurance law
to redefine the terms "qualified counterparty" and "aggregate
counterparty exposure" and to refine the rules which insurers must
follow in order to enter into derivative transactions with "qualified
counterparties" and other than qualified counterparties. The new
standard provided for in this bill will require that, in order for a
counterparty to be a "qualified counterparty" it would need to have
entered into a netting and collateral agreement with the insurer and
would also need to he rated (or have a parent or guarantor or other
credit enhancer rated) investment grade or better.

EXISTING LAW:
Section 1401 of the insurance law currently does not
define the terms over the counter derivative instrument",
"clearinghouse" and "master agreement." Section 1410 of the insurance
law currently contains an alternative definition for "qualified
counterparty" and "aggregate counterparty exposure." The current
definitions of these terms are meant to establish that, in order to
be qualified to enter into a derivative transaction with an insurer,
an entity must have a credit rating of AA or better by a
nationally-recognized statistical rating organization. The current
restrictions contained in section 1410 of the insurance law and
placed on insurers entering into derivative transactions remain intact.


JUSTIFICATION:
Section 1410 of the insurance law was adopted in 1998
to establish the rules which domestic insurers must follow in order
to enter into derivative transactions in New York. The law strictly
limits the amount of derivative transactions that insurers may enter
into and provides that they should be used primarily for hedging
purposes. It also requires that insurer derivative use must be
overseen by the company Board of Directors and requires that insurers
must have a derivative use plan approved by the Superintendent and
audited by an independent, outside auditing firm. This law has proven
to be successful in ensuring that insurers in New York are limited to
entering only into appropriate derivative transactions which are
suitable for their level of assets, By requiring that
these transactions are used primarily for the purposes of hedging,
this law has allowed insurers to have the ability to adjust to the
changing markets during the recent economic downturn.

Most importantly, the ability to enter into responsible and
well-regulated derivative transactions, primarily for the purposes of
hedging insurer investment strategies, has enabled insurers to
continue to offer certain variable life insurance products that are
currently very popular with consumers and also allowed them 10 offer
their products at more affordable rates, since the 2008 economic
downturn.

Chapter 650 of the Laws of 1998 allowed for certain, expanded insurer
derivative use authority with restrictions and significant oversight
by insurer Boards, the Superintendent of the Department of Financial
Services and outside auditors. Under the current law, insurer
derivative transactions with counterparties which are not "qualified
counterparties" are subject to strict quantitative limits. The term
"qualified counterparty" is defined as a counterparty rated AA or
higher by at least one nationally recognized statistical rating
organization and meeting certain other qualifications. These
standards were carried over from earlier law governing insurance
derivative transactions and, even in 1998, did not reflect the actual
counterparty universe. Current derivatives markets and participants
are considerably different from that which were in place in 1998 and,
following the restructuring of this market due to certain provisions
of the Federal Dodd-Frank Wall Street Reform and Consumer Protection
Act, additional changes are occurring.

The primary counterparties with which insurers enter into derivatives
transactions are banks. Bank ratings have deteriorated markedly since
1998 and are expected to continue to decline. On February 15, 2012,
Moody's announced a review for downgrade of the long-term debt
ratings of 17 banks and securities firms with global capital markets
operations. This action will likely result in additional downgrades
in this sector. The downgrading of insurer banking counterparties
will reduce the number of qualified counterparties available, perhaps
even to the point where there will no longer be any "qualified
counterparties" under New York law.

The current law is also outdated in its enumeration of types of
qualified counterparties. It includes registered broker dealers,
which no longer engage in this business, and does not include either
foreign banks or non-rated derivatives dealers guaranteed by a parent


or affiliate, both of which are major participant categories in this
market. Also, the Federal Dodd-Frank Act will begin to require that
banks must spin off certain of their derivatives activities into
affiliate entities and many of these newly-created entities will not
meet the current AA standard necessary in order to be determined a
"qualified counterparty".

The utility of using rating categories to define a "qualified
counterparty" has been called into question since the 2008 economic
downturn when several very highly rated banking organizations were
downgraded to junk status overnight. Recognizing this, many, if not
most, insurers have moved to the use of standard netting and
collateral agreements, under which the counterparty's obligations to
the insurer are collateralized, subject to normal credit thresholds
and minimum transfer amounts. This has greatly reduced the risk to
insurers of these trading relationships.

This bill would codify the responsible practice of collateralizing
these types of transactions by requiring that a "qualified
counterparty" will need to have entered into a netting and collateral
agreement with the insurer and would also need to be rated (or have a
parent or guarantor or other credit enhancer rated) investment grade
or better.

Enactment of this bill will result in simplification of the current
"qualified counterparty" standard to more flexibly reflect current
and future market conditions, will permit lower rated counterparties
to be qualified, so long as collateral arrangements are entered into
to protect insurers and their policyholders, and will update the law
for the new Dodd-Frank era derivatives marketplace.

By making these refinements to the current law, insurers will be
enabled to continue entering into responsible derivative transactions
in the limited manner provided for in the current law, with the
continuing oversight by their
Board of Directors and the NYS Department of Financial Services. It
will also enable insurers to continue offering certain variable life
insurance products that are currently very popular with consumers and
to offer these and other products at more affordable rates.

LEGISLATIVE HISTORY:
New bill.

FISCAL IMPLICATIONS:
None.

EFFECTIVE DATE:
Immediately.

S7306A-2011 Text

 S T A T E   O F   N E W   Y O R K
 
 7306--A
 I N  SENATE
 May 2, 2012
 
 Introduced  by  Sen.  SEWARD -- read twice and ordered printed, and when
 printed to be committed to the Committee  on  Insurance  --  committee
 discharged, bill amended, ordered reprinted as amended and recommitted
 to said committee
 AN  ACT  to  amend  the  insurance law, in relation to derivative trans
 actions and derivative instruments
 THE PEOPLE OF THE STATE OF NEW YORK, REPRESENTED IN SENATE AND  ASSEM
 BLY, DO ENACT AS FOLLOWS:

 

Section  1.  Subsection  (a)  of  section 1401 of the insurance law is
 amended by adding three new paragraphs 19, 20 and 21 to read as follows:

 (19) "OVER THE  COUNTER  DERIVATIVE  INSTRUMENT"  MEANS  A  DERIVATIVE
 INSTRUMENT  WHICH  IS AUTHORIZED UNDER THIS CHAPTER OTHER THAN A DERIVA
 TIVE INSTRUMENT (A) CLEARED THROUGH A UNITED STATES OR FOREIGN CLEARING
 HOUSE OR (B) TRADED ON OR THROUGH A UNITED STATES  OR  FOREIGN  EXCHANGE
 PROVIDING CLEARING SERVICES.
 (20)  "CLEARINGHOUSE"  MEANS A DERIVATIVES CLEARING ORGANIZATION WHICH
 ACTS AS A MEDIUM FOR CLEARING, OR EFFECTING SETTLEMENTS  OF,  DERIVATIVE
 INSTRUMENTS  SUCH  THAT  THE  CLEARINGHOUSE  IS SUBSTITUTED AS THE OTHER
 PARTY TO THE DERIVATIVE TRANSACTION.
 (21) "MASTER AGREEMENT" MEANS A WRITTEN MASTER AGREEMENT  RELATING  TO
 DERIVATIVES  TRANSACTIONS  THAT PROVIDES FOR NETTING OF PAYMENTS OWED BY
 THE RESPECTIVE PARTIES, AND THE DOMICILIARY JURISDICTION OF THE COUNTER
 PARTY IS EITHER WITHIN THE UNITED STATES OR IF  NOT  WITHIN  THE  UNITED
 STATES,  WITHIN A FOREIGN (NOT UNITED STATES) JURISDICTION DEEMED BY THE
 SECURITIES VALUATION OFFICE OF THE  NATIONAL  ASSOCIATION  OF  INSURANCE
 COMMISSIONERS, OR ANY SUCCESSOR OFFICE ESTABLISHED BY THE NATIONAL ASSO
 CIATION OF INSURANCE COMMISSIONERS, AS ELIGIBLE FOR NETTING.
 

S  2. Subsection (f) of section 1410 of the insurance law, as added by
 chapter 650 of the laws of 1998, is amended to read as follows:

 (f)(1) The counterparty exposure under [a] AN OVER THE COUNTER deriva
 tive instrument entered into by an insurer authorized to engage in tran
 sactions pursuant to this section shall be deemed to be an obligation of
 the institution to which the insurer is exposed to credit risk and shall
 be included in determining compliance with any single or aggregate quan
 EXPLANATION--Matter in ITALICS (underscored) is new; matter in brackets
 [ ] is old law to be omitted.
 LBD15578-02-2
        S. 7306--A                          2
 titative limitation on investments made by an insurer under  this  chap
 ter.
 (2) Notwithstanding any single or aggregate quantitative limitation on
 investments  made  by an insurer under this chapter, AN INSURER MAY ONLY
 TRANSACT AN OVER THE COUNTER DERIVATIVE INSTRUMENT WITH:

 (A) A QUALIFIED COUNTERPARTY; OR
 (B) A COUNTERPARTY OTHER THAN A  "QUALIFIED  COUNTERPARTY"  IF,  AFTER
 GIVING  EFFECT  TO THAT TRANSACTION, the aggregate counterparty exposure
 OF THE INSURER under one or more OVER  THE  COUNTER  derivative  [trans-
 actions] INSTRUMENTS to:

 [(A)  any  single counterparty, other than a "qualified counterparty",
 shall be limited to one] (I) THAT NON-QUALIFIED  COUNTERPARTY  DOES  NOT
 EXCEED ONE percent of [an] THE insurer's admitted assets; and
 [(B)]  (II)  all  counterparties, other than qualified counterparties,
 [are limited to] DOES NOT EXCEED three percent  of  [an]  THE  insurer's
 admitted assets.
 (3) For purposes of this section:

 (A) a "qualified counterparty" is a ["qualified broker or dealer" or a
 "qualified  bank"  or  other  counterparty  rated AA-/Aa3 or higher by a
 nationally recognized statistical rating  organization  if  it  is  also
 approved by the superintendent;
 (B)  a  "qualified  broker or dealer" means a broker or dealer that is
 organized under the laws of a state and is registered under the  Securi-
 ties Exchange Act of 1934, 15 U.S.C. SS 78a-78kk, and has net capital in
 excess of two hundred fifty million dollars;
 (C) a "qualified bank" means a bank or trust company that:
 (i) is organized and existing, or in the case of a branch or agency of
 a foreign banking organization is licensed, under the laws of the United
 States or any state thereof;
 (ii) is regulated, supervised and examined by United States federal or
 state  authorities  having  regulatory  authority  over  banks and trust
 companies;
 (iii) has assets in excess of five billion dollars;
 (iv) has senior obligations outstanding, or has a  parent  corporation
 that  has  senior  obligations  outstanding,  rated AA or better (or the
 equivalent thereto) by two independent nationally recognized statistical
 rating organizations; and
 (v) has a ratio of primary capital to total assets of  at  least  five
 and  one-half percent and a ratio of total capital to total assets of at
 least six percent; and
 (D)] COUNTERPARTY WITH WHICH THE INSURER HAS  ENTERED  INTO  A  MASTER
 AGREEMENT,  TOGETHER  WITH A CREDIT SUPPORT ANNEX OR OTHER DOCUMENTATION
 PROVIDING FOR THE COLLATERALIZATION OF THE COUNTERPARTY'S OBLIGATIONS TO
 THE INSURER UNDER THE MASTER  AGREEMENT  AND  WHICH  MEETS  ONE  OF  THE
 FOLLOWING RATING STANDARDS:

 (I)  AN  INVESTMENT  GRADE  CREDIT RATING FROM AT LEAST ONE NATIONALLY
 RECOGNIZED STATISTICAL RATING ORGANIZATION;
 (II) WHOSE PARENT HAS AN INVESTMENT GRADE CREDIT RATING FROM AT  LEAST
 ONE NATIONALLY RECOGNIZED STATISTICAL RATING ORGANIZATION; OR
 (III)  THAT HAS CREDIT ENHANCEMENT FOR ALL OF ITS FINANCIAL OR SETTLE
 MENT OBLIGATIONS UNDER THE OVER THE COUNTER  DERIVATIVE  INSTRUMENT  FOR
 THE  DURATION  OF  THE  DERIVATIVE INSTRUMENT FROM AN ENTITY THAT HAS AN
 INVESTMENT GRADE CREDIT RATING FROM AT LEAST ONE  NATIONALLY  RECOGNIZED
 STATISTICAL RATING ORGANIZATION FOR THE BENEFIT OF THE INSURER; AND
 (B)  "aggregate  counterparty  exposure"  means  the  [sum of: (i) the
 aggregate statement value  of  options,  swaptions,  caps,  floors,  and
        S. 7306--A                          3
 warrants  purchased;  and  (ii)  the  aggregate  potential  exposure  of
 collars, swaps, forwards and futures entered into] AGGREGATE, NET AMOUNT
 OF CREDIT RISK ATTRIBUTABLE TO ALL OVER THE COUNTER  DERIVATIVE  INSTRU
 MENTS ENTERED INTO WITH A COUNTERPARTY, CALCULATED AS FOLLOWS:

 (I)  IF  THERE  IS NO MASTER AGREEMENT IN PLACE WITH THE COUNTERPARTY,
 THE SUM OF THE MARKET VALUES OF ALL OVER THE COUNTER DERIVATIVE  INSTRU
 MENTS  WITH THE COUNTERPARTY THAT HAVE A POSITIVE MARKET VALUE, LESS ANY
 COLLATERAL; OR
 (II) IF A MASTER AGREEMENT IS IN  PLACE  WITH  THE  COUNTERPARTY,  THE
 GREATER OF ZERO OR THE NET SUM PAYABLE TO THE INSURER IN CONNECTION WITH
 ALL  OVER  THE  COUNTER  DERIVATIVE  INSTRUMENTS  SUBJECT  TO THE MASTER
 NETTING AGREEMENT, LESS ANY COLLATERAL.
 

S 3. This act shall take effect immediately.

S7306A-2011: Relates to derivative transactions and derivative instruments