INDICADOR ESTADO DEL
5. CONCLUSIONES Y RECOMENDACIONES
3.1.2.1 Legal Definitions
The scope of insurance law cannot be definitively demarcated by definitions, but they are necessary as a matter of first impression. Although there is some variation among the conventional legal definitions of insurance, two things are without doubt: the definitions agree on the fundamentals, and those fundamental elements embrace all or many credit default swaps.11 In the United States, a
standard definition by Black’s Law Dictionary states that insurance is a “contract by which one party (the insurer) undertakes to indemnify another party (the insured) against risk of loss, damage, or liability arising from the occurrence of some specified contingency.”12 A more elaborate definition is provided by New
York State Insurance Law:
“Insurance contract” means any agreement or other transaction whereby one party, the “insurer,” is obligated to confer benefit of pecuniary value upon another party, the “insured” or “beneficiary,” dependent upon the happening of a fortuitous event in which the insured or beneficiary has, or is expected to have at the time of such happening, a material interest which will be adversely affected by the happening of such event.13
Afortuitous event means, according to the New York statute, “any occurrence or failure to occur which is, or is assumed by the parties to be, to a substantial extent beyond the control of either party.”14
8 See Clarke 2007: 98–116 (discussing this principle critically). 9 Ibid.
10 Hazen 2005: 431–432 (2005).
11 This discussion is largely limited to United States and English law, which are the leading
jurisdictions for CDS markets; the demarcation of insurance law does not appear fundamentally different in other jurisdictions, although there are differences in the details of insurance regulation.
12 Black’s Law Dictionary 2009: 870 (9th ed. 2009). 13 New York Insurance Law, § 1101(a)(1).
In the UK, there are some statutes dealing with insurance law, but the demarcation of insurance continues to be determined by common law and the regulators’ interpretation thereof.15 In the landmark case of Prudential v IRC,
Channell J described insurance as follows:
A contract of insurance, then, must be a contract for the payment of a sum of money, or for some corresponding benefit such as the rebuilding of a house or the repairing of a ship, to become due on the happening of an event, which event must have [...] some degree of uncertainty about it and must be of a character more or less adverse to the interest of the person effecting the insurance.16
In summary, there are three fundamental elements of insurance contracts: payment, uncertainty and adverseness (interest).17 It is evident that the broad
definitions would include CDSs, at least in some cases, as many commentators acknowledge: “A CDS certainly appears to fall within this definition [of Black’s Law Dictionary].”18 Even Schwartz, who is critical of insurance law, agrees:
“Viewed on their face, these [New York] statutes define insurance contracts such that CDS—at least those with exogenous credit events—could be subject to insurance regulation.”19 He also notes that guidelines issues by the United States
National Association of Insurance Commissioners “defined insurance in such a way that CDS clearly qualify as insurance contracts.”20
Some have attempted to downplay the issue by referring to non-legal definitions of insurance, such as those highlighting the risk-pooling aspect of insurance.21 But, while risk pooling is an important aspect of the economic logic
of ordinary insurance business, it is not a legal criterion for demarcating insurance law.
15 See FSA 2012: para. 6.3.2, 6.5.2; Clarke 2007: 349 (explaining that the Regulated Activities
Order “does not attempt an exhaustive definition of contracts of insurance” and that the “FSA will still consider each case on its merits, in the light of the FSA’s interpretation of the common law.”). In fact, many countries do not have statutory definitions of insurance; for example, Australia’s Insurance Contracts Act 1984, s. 10(1), simply refers to what “would ordinarily be regarded as a contract of insurance”.
16Prudential Insurance Company v IRC [1904] 2 KB 658, 663. According to FSA 2012: para.
6.5.1, Prudential is the best statement of the common law.
17 English and Scottish Law Commissions 2008: para. 7.19. For similar definitions, see for
example Ivamy 1993: 3–4; Leigh-Jones, Birds and Owen 2003: para. 1–1.
18 Sjostrom 2009: 987. 19 Schwartz 2007: 181. 20 Ibid. 174.
CDS IN LIGHT OF INSURANCE LAW PRINCIPLES
3.1.2.2 Borderline Cases
Definitions are not the final word: demarcations must be determined by courts and regulators, which are sceptical of generic definitions, “because definitions tend sometimes to obscure and occasionally to exclude that which ought to be included.”22 Even when a definition is provided by statute, it should not be
blindly relied upon, as “the approach through formal definition leads to innumerable difficulties and, if taken seriously, unfortunate results.”23
There is no simple way of determining borderline cases.24 Courts at common
law have developed a range of criteria based on the peculiarities of new cases.25
These seem to have little to add to the present discussion, as many of these criteria are trivial and easily fulfilled in CDSs.26 There are only two criteria that raise
questions with respect to CDSs. One is that “the insured event must be one that is adverse to the policyholder”;27 but this is only relevant for some (so-called
uncovered or “naked”) CDSs, and will be discussed later in detail.
Another potentially relevant criterion is the “major or primary purpose test” developed in some United States cases, according to which “where the major purpose of a contract is other than to indemnify the promise, there is no insurance.”28 However, the validity of this test is doubtful, as it is contradicted by
some cases and “cannot prevail as a general test”.29 In the UK, the regulators have
expressly abolished it: “The contract must be characterised as a whole and not according to its ‘dominant purpose’ or the relative weight of its ‘insurance content’.”30 Moreover, in any case this test might not matter for CDSs, because it
can be argued that the purpose—in fact, the only purpose—of CDSs is precisely
22Department of Trade and Industry v St. Christopher Motorists Association [1974] 1 All ER 395,
396–397. See alsoClarke 2007: 347–352 (discussing the limits of definitions).
23 Hellner 1963: 495.
24 Hellner 1963: 495–504 (discussing various tests and their limits).
25 See Clarke 2007: 350 (describing features highlighted by English courts); Hellner 1963:
500–512 (discussing United States cases).
26 For example, Clarke 2007: 350 lists the following criteria: the provision of insurance must
be a business of a certain degree of regularity (even if insurance is just one part of its business); the insurer’s promise to pay must be “in money or in kind”; “the alleged insurer must be legally (i.e., contractually) bound to pay the money or provide the benefit in kind […] and the beneficiary must have a legally enforceable right to receive it”; and “the benefit is due only if a specified insured event occurs. Moreover, at the time of contracting, it must be uncertain whether the specified event will occur.”
27 Ibid.
28 Hellner 1963: 502. 29 Ibid.
30 FSA 2012: para. 6.5.4(3) (citing Fuji Finance Inc. v. Aetna Life Insurance Co. Ltd [1997] Ch.
to indemnify, or to recover the loss of reference asset value due to default or other credit event.31
Some authors have argued that “attempts at evasion of insurance regulation should not be tolerated,” giving rise to a kind of positive presumption in favour of regulation.32 This is relevant with respect to CDSs, because the very language
of “swaps” may be interpreted as a camouflage.
3.1.2.3 UK Financial Services Authority (FSA) Guidelines
In the UK, the difficulty of delineating the boundaries of insurance law has prompted the Financial Services Authority (FSA)—which supervised both securities and insurance industries—to provide further guidance.33 This guidance
is not conclusive and does not explicitly discuss CDSs, but it corroborates the impression that English insurance law covers CDSs.
Firstly, the FSA lists transactions that are unlikely to be regarded as insurance: these include contracts which appear to be “pre-payment for services to be rendered in response to a future contingency”;34 contracts of “periodic
maintenance of goods or facilities”;35 and contracts under which “the provider
stands ready to provide services on the occurrence of a future contingency, on condition that the services actually provided are paid for by the recipient at a commercial rate”.36 CDSs resemble none of these transactions.
Secondly, in terms of affirmative criteria, the FSA highlights the “assumption of risk” by the insurer as “an important descriptive feature of all contracts of insurance.”37 For the FSA, the assumption of risk has the same meaning as the
“transfer of risk”.38 This is precisely the fundamental element of CDSs. Note that
it does not matter if the provider “trades without any risk”,39 as may be the case
with an investment bank acting as a CDS intermediary.
With respect to borderline cases, the FSA notes that insurance law is more likely to apply “if the amount payable by the recipient under the contract is
31 This will be discussed in detail below, chapter 3.1.6.1. The point of the major purpose
test is not to scrutinize the motivations of the insured party (which in CDS transactions may be speculative), but to distinguish contracts which have only a marginal insurance element: see Hellner 1963: 502–503.
32 See Hellner 1963: 503–504 (discussing this argument).
33 The original document is FSA 2004, which has been published in updated form in FSA
2012: chapter 6. 34 FSA 2012: para. 6.6.3. 35 Ibid. para. 6.6.4. 36 Ibid. para. 6.6.5. 37 Ibid. para. 6.6.2. 38 Ibid. para. 6.6.2(1). 39 Ibid. para. 6.6.2(3).
CDS IN LIGHT OF INSURANCE LAW PRINCIPLES
calculated by reference to either or both of the probability of occurrence or likely severity of the uncertain event.”40 With CDSs, this is the case, at least in practice,
because CDS premiums or spreads reflect expectations of probability and severity of credit events.41 Also, the FSA states that a contract is less likely to be insurance
“if it requires the provider to assume a speculative risk (ie a risk carrying the possibility of either profit or loss) rather than a pure risk (ie a risk of loss only).”42
CDSs transfer the risk of loss only, because credit events are always downside risks in terms of reference asset value.
In the FSA guidance, the only factor against the insurance characterization of CDSs is that a contract is more likely to be insurance if it “is described as insurance and contains terms that are consistent with its classification as a contract of insurance, for example, obligations of the utmost good faith”43 (which is not the
case with CDSs). However, the guidance goes on to note that what matters is the substance, and the contract “does not cease to be a contract of insurance simply because the terms included are not usual insurance terms.”44 This is a
fundamental point of principle, which Jan Hellner clarifies as follows:
Although there are good reasons for submitting anything that is frankly called insurance to insurance regulation, since the public might otherwise be misled, the test is clearly unsuitable when applied to business which is not called insurance for then an easy way to avoid the burden of regulation would be to use another name.45
It may be concluded that the characterization issue is asymmetric in nature. The use of insurance language renders insurance characterization morelikely, but its avoidance does not, in and of itself, make insurance characterization unlikely.