Obtención del espacio de estado teórico

3.1.3.1 The Potts Opinion

The argument for insurance recharacterization seems strong, then, but there is a persistent belief that CDSs are not insurance. This belief goes back to a legal

40 _{Ibid. para. 6.6.8(1).}

41 _{Banks, Glantz and Siegel 2007: 34 (“The premium is a function of various factors,}

including time to maturity, probability of reference credit default, expected recovery rate given default” etc.).

42 _{FSA 2012: para. 6.6.8(2).} 43 _{Ibid. para. 6.6.8(3).} 44 _{Ibid. para. 6.6.8(4).} 45 _{Hellner 1963: 500.}

opinion on credit derivatives penned in 1997 by Robin Potts QC in London for ISDA.46 _{After examining the principles, Potts concluded:}

I think that credit default options [sic] plainly differ from contracts of insurance in the following critical respects:-

(a) the payment obligation is not conditional on the payee’s sustaining a loss or having a risk of loss;

(b) the contract is thus not one which seeks to protect an insurable interest on the part of the payee. His rights do not depend on the existence of any insurable interest.47

Potts went on to admit that “the economic effect of certain credit derivatives can be similar to” insurance, but argued that “economic effect is not the test to be applied to the characterisation of the transaction.”48 _{Instead, the question depends}

on the intended rights and obligations specified in the contract.49 _{Potts also}

recommended that the contract include a clause insisting that the parties wish the obligations to exist regardless of whether the protection buyer suffers or is exposed to a loss, and “therefore this transaction is not a contract of insurance”.50

3.1.3.2 The Importance of the Potts Opinion

Before analyzing Potts’ reasoning critically, it is worth highlighting its practical importance. In the words of an anonymous ISDA representative, “there would have been no market at all” in CDSs in the absence of the Potts opinion.51 _{The core}

of Potts’s argument has also been repeated on numerous occasions by ISDA.52 _The

rhetorical weight of the Potts opinion has been so impressive that in a 2006 letter to the English Law Commission, ISDA Senior Policy Director Richard Metcalfe

46 _{Potts 1997: 1 (para. 1).} 47 _{Ibid.7 (para. 5).} 48 _Ibid. 49 _Ibid. 50 _{Ibid.8 (para. 6).}

51 _{Cited in interview by Huault and Rainelli-Le Montagner 2009: 560.}

52 _{See for example Pickel 2004 (arguing on similar grounds that weather derivatives are}

not insurance). See likewise Strupp and Darras 2009: 2, which is a joint letter by ISDA and SIFMA and asserts among other things the following: “Whereas insurance requires an insurable interest, credit default swaps are often purchased by protection buyers that are not hedging a specific underlying risk. Insurance contracts generally are purchased and held by the buyer, whereas CDS are frequently bought and sold. And finally, insurance contracts only pay out when the insured party actually incurs a loss. CDS provide for payments to protection buyers upon the occurrence of a credit event, which frequently occurs before any loss is incurred. We believe each of these factors marks a significant difference between CDS and insurance.”

CDS IN LIGHT OF INSURANCE LAW PRINCIPLES

invoked the authority of the “widespread acceptance of the so-called ‘Potts opinion’” which had come to represent “current market consensus.”53

In reality, though, such “widespread acceptance” was driven by a group of London-based banking lawyers repeating the Potts opinion in a range of publications. For example, a group of Allen & Overy solicitors—connected with the Potts opinion itself—made the same argument in 1997.54 _{In 2001, Norton Rose}

lawyers advanced essentially the same argument,55 _{and in 2003, ISDA}

documentation expert Paul Harding referred to the Potts opinion as definitive.56

3.1.3.3 Mixed Reception

Yet there are obvious problems with the Potts opinion. This subsection highlights some general issues, which will be followed by a detailed analysis of the legally more complex issues—form and substance, insurable interest, and loss indemnification—in separate sections below. The Potts opinion is famous, but legally it is only a private opinion. Its acceptance by the market—that is, a market keen to be freed from the shackles of regulation—is hardly surprising, and certainly does not render it legally binding. Its repetition by many a bank counsel must also be read in context, as the literature on credit derivatives law is sparse and dominated by banking interests.

Moreover, the acceptance of the Potts opinion has been hugely exaggerated. Joanna Benjamin in 2007 wrote—while expressing doubts about the accuracy of Potts’ analysis—that “given the degree of authority commanded by the Potts opinion in the financial markets, and given also the importance of commercial expectations in characterising financial contracts, the opinion may now be regarded as conclusive.”57 _{But in fact, already in 1998 Professor Hudson wrote}

that credit derivatives basically provide “a form of insurance policy for the buyer”58 _{and that they imply “a number of areas of potential liability where}

dealers are, in terms, providing insurance to their clients”.59 _{In 2000, John}

Jakeways also advanced a more nuanced position on the insurance question.60 _In

his view, there was no definite answer to the question, as it depended on the specific terms of each contract; he felt that most of the time credit derivatives were

53 _{Metcalfe 2006.}

54 _{Benton, Devine and Jarvis 1997: 30–31. Benton was one of the two Allen & Overy}

Instructing Solicitors acting for ISDA in requesting the Potts opinion: see Allen & Overy 1997: 10.

55 _{Ross and Davies 2001.} 56 _{Harding 2004: 18–19.}

57 _{Benjamin 2007: 142 (para. 5.142) n.426.} 58 _{Hudson 1998: 5.}

59 _{Ibid. 14.}

probably not insurance, but nothing certain could be said.61 _{In his opinion, the}

basis for avoiding the application of insurance law is that the principal object of the transaction is other than to insure.62 _{Ali and de Vries Robbé in 2005 likewise}

highlighted the continuing risk that credit derivatives might be recharacterized as insurance.63 _{Finally, Benjamin Saunders in 2010 argued that at least some}

CDSs—“for example a bank entering a CDS to protect against borrower default”—are “a form of indemnity insurance.”64

If, in reality, the academic opinion has diverged from Potts on many points, the reception of the Potts opinion by regulators has been even more sceptical.65 _In

the UK, the Potts opinion was explicitly discussed by the FSA in a 2002 study on cross-sector risk transfers, and was found incorrect in several respects (although the FSA refrained from pronouncing expressly on whether it considered CDSs to be insurance).66 _{The FSA listed four reasons why the Potts opinion should not be}

heavily relied upon: (i) some contracts may not have “no intention to insure” clauses; (ii) the reference event may have been defined in such a way that it is conceptually impossible for the event to occur without the protection buyer suffering a loss; (iii) there are also contracts of insurance that do not provide indemnity against actual loss; and (iv) “no intention to insure” clauses may not be definitive if there is evidence of a different true intention.67

The Potts opinion was also discussed by the English and Scottish Law Commissions’ 2008 study on insurable interest, and not without scepticism.68

Paradoxically, the authors of the report seemed bent on avoiding the conclusion that CDSs are insurance, but nowhere did they give clear reasons for this objective.69 _{The only explanation offered was industry pressure: “In response to}

61 _{Ibid. 51–53.}

62 _{Ibid. 54–55. But this seems mistaken, because the major or dominant purpose test has}

been shown to be incorrect. With respect to speculative intent using insurance-like transactions, these are limited by the doctrine of insurable interest.

63 _{Ali 2005: 308(“Notwithstanding the tremendous growth of the global credit derivatives}

market, there remains a critical legal risk […] that a court will treat the assumption of credit risk by a Protection Seller under a credit derivative as tantamount to the (illegal) provision of insurance by the party.”). Ali and de Vries Robbé 2005: 181 (”In the absence of a statutory safe harbour for credit derivatives and synthetic securitisations from the insurance laws, those products remain subject to the risk that a regulator or court may characterise them as insurance contracts.”).

64 _{Saunders 2010: 435.}

65 _{In addition to the sources cited here, see the discussion on United States insurance}

regulators below.

66 _{FSA 2002: Annex B, p. 2.} 67 _Ibid.

68 _{SeeEnglish and Scottish Law Commissions 2008: paras 7.10–7.17 (mainly citing the FSA}

publications).

CDS IN LIGHT OF INSURANCE LAW PRINCIPLES

our scoping paper, the ISDA wrote to us describing Robin Potts QC’s opinion and said that ‘any review of the boundary between contracts of insurance and other types of contract risks damaging [market] consensus and undermining confidence in these economically significant products’.”70 _{In the United States, as}

will be seen later in detail, insurance regulators initially accepted ISDA’s Potts- like argumentation, but it was scrutinized more carefully after the financial crisis, and rejected.