Guidance to Insurance Companies regarding the Use of Basis Swaps by Clearing Parties in connection with the upcoming LIBOR Transition

Guidance Date: July 27, 2020

In connection with the upcoming transition from the London Interbank Offered Rate (“LIBOR”) to the Secured Overnight Financing Rate (“SOFR”) as the benchmark reference rate, certain clearing parties (“CCPs”), including the Chicago Mercantile Exchange (“CME”) and the London Clearing House (“LCH”), will replace the discounting rate currently utilized for all cleared swaps from the Effective Federal Funds Rate (“EFFR”) to SOFR.  As part of this change, the CCPs will revalue existing cleared swap transactions and issue basis swaps to all affected counterparties, including insurers, on a mandatory basis. The purpose of this basis swap allocation is to restore each counterparty’s original risk profile in the swap transaction and is expected to be a one-time solution for this revaluation.

Section 1410 of the New York Insurance Law governs the use of derivatives by insurers licensed in New York.  Generally, insurers are required to limit the use of derivatives to activities such as hedging, replication and, in some cases, income generation.  The use of basis swaps as described above is not contemplated by Section 1410.  Accordingly, the Department of Financial Services is issuing the following guidance to allow insurers (as defined in Section 1410) to deem basis swaps received by insurers as a result of a change to the CCPs' discounting rates in connection with the LIBOR transition to be hedging transactions:

“For the purposes of Insurance Law §1410, any basis swap received by an insurer (as defined in Insurance Law §1410) in connection with a clearing party’s replacement of the discounting rate for cleared swaps from the federal funds effective rate to the secured overnight financing rate (a “CCP Cutover”) shall be deemed an effective hedging transaction notwithstanding any other provision of Insurance Law §1410, or such insurer’s derivatives use plan, so long as the insurer has documented the fact that it has received such basis swap in connection with a CCP Cutover. This guidance is applicable for a period not to exceed 1 year after the date of the CCP Cutover”.