September 7, 1995
Mr. Michael E. Surguine
National Association of Insurance Commissioners
120 West 12th Street, Suite 1100
Kansas City, MO 64105-1925
Dear Mr. Surguine:
The Foreign Exchange Committee (Committee) is a group of approximately 30 foreign exchange professionals from a variety of institutions, including: money center, regional, and foreign commercial banks; investment banks; and foreign exchange brokers. The Committee's main purpose is to advise officials at the Federal Reserve Bank of New York on issues related to the foreign exchange market. Attached you will find our Document of Organization as well as a list of 1995 Committee members.
The Committee strongly supports the NAIC's amendment of the Model Act to incorporate the concept of enforcing the close-out and netting provisions of master agreements relating to derivative transactions. However, the Committee believes that certain aspects of the proposed amendments should be modified or clarified in order to facilitate their implementation by market participants. The Committee's suggestions are outlined below.
DEFINITION OF "DERIVATIVE INSTRUMENTS"
The definition of Derivative Instruments contained in section 2P of the Investments of Insurers Model Act and incorporated by reference into the proposed amendments should be clarified to expressly include spot transactions which settle in two days or less. Such transactions are common in foreign exchange as well as in commodities and bullion markets. Otherwise, it would remain uncertain as to whether spot transactions were included in the terms "forwards . . . and transactions substantially similar thereto."
Further, the definition of Derivative Instruments should be revised to clarify that the term would include any derivative transactions, regardless of whether they are related to interest rates, foreign exchange, commodities, or equity securities.
DEFINITION OF "NETTING AGREEMENT"
The proposed definition of Netting Agreement should be modified to state that the master agreement, together with "any and all schedules and supplements thereto, and all confirmations exchanged thereunder" must be treated as one netting agreement in order to avoid the possibility of "cherry picking."
The proposed definition of Netting Agreement should also be expanded to address the possibility that (I) there may be a cross-product master master netting agreement which does not directly document derivative transactions and (ii) some master agreements may concern non-derivative transactions (e.g., securities lending).
CLOSE-OUT AND NETTING PROVISIONSSection 46.A.1. of the proposed amendment should be modified to permit the enforcement of the close-out and netting provisions of a master agreement upon any delinquency proceeding (not simply upon commencement of a formal delinquency proceeding). A counterparty should have the option to close-out and net exposures under an existing agreement, upon the commencement of a conservatorship proceeding in respect of an insurer.
The NAIC should ensure that, to the extent that only certain states adopt the proposed amendments, the determination of governing law and the treatment of the enforcement of the close-out and netting provision of a master agreement upon any default by an insurer doing business in several states (not all of which have adopted the proposed amendments) should be clear, regardless of the type of default.
Section 46.C of the proposed amendment suggests that a receiver may transfer an insurer's rights under a netting agreement to another insurer. This Section should be made subject to the right of a non-defaulting counterparty to exercise its right to terminate the netting agreement, and to close-out and net any transactions with the insolvent insurer, as provided in Section 46.A.1.
Section 46.F of the proposed amendment suggests that a receiver may repudiate a netting agreement. This Section should be clarified to provide that the receiver's right to repudiate is subject to the requirement that the receiver treat any netting agreement, and all schedules and supplements thereto and all transactions thereunder, as one agreement as provided in the definition of netting agreement. A receiver should not be able to "cherry pick" between derivative transactions and repudiate only those transactions which are unprofitable to the insolvent insurer.
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We appreciate the opportunity to comment on the proposed amendments to the Rehabilitation and Liquidation Model Act. Should you have any questions regarding our comments, please contact me at 415/622-1677 or David Carangelo, the Committee's Executive Assistant, at 212/720-2226.
Lewis W. (Woody) Teel