The statement from the European Parliament said the rules will “virtually ban certain CDS trades, thereby making speculation on a country’s default more difficult”. The rules will also increase the powers of European Securities and Markets Authority (ESMA), the EU’s financial watchdog.
Creating volatility
The background to the EU Parliament’s actions is to control short-selling and CDS trading that have both been accused of fuelling market volatility, with CDS trades widely blamed for aggravating Greek’s debt woes.
There is now a ban on naked CDS trading although there is an exception where an individual national authority can lift the ban if its sovereign debt market is not functioning properly.
In support of the ban, Pascal Canfin (Greens, Fr) said: “Today’s compromise will make it impossible for a hedge fund to buy Greek or Italian CDS without already owning the bonds of those countries, for the sole purpose of speculating on the country’s default."
Arguing counter to the move is the professor of finance at Cass Business School, Ian Marsh, who said: “Banning speculators from buying insurance while allowing hedgers to do so actually favours the people who made the initial mistake – the banks who lent the money – while harming the speculators who pointed out the problem.
“EU politicians are talking to two audiences as they impose reforms and regulations. The first is their electorate where they want to be seen to be doing something about the crisis. Banning naked CDS writing will seem like a good thing to most of the population. Their other audience is the financial markets who will, I suspect, see this as another instance of the authorities blaming the wrong people and imposing the wrong policies.”
Agreement to come
Another opposing voice belongs to Andrew Shrimpton, a member at financial advisory firm Kinetic Partners, who added: “The proposed ban will reduce liquidity in the CDS market, leading to increased volatility of CDS prices, undermine confidence in member state sovereign bonds, and make it more expensive for member states to finance budgets.
“This has been demonstrated by similarly ill-timed regulatory tightening such as the banning by France, Italy, Belgium and Spain of the short selling of financial stocks earlier this year, which undermined confidence in bank stocks, reduced liquidity in the banking system and eventually led to a taxpayer-funded bailout of Dexia.”
The new rules include extra information being reported to national and European authorities with, for example, supervisors being told of large short positions that account for 0.5% of the issued capital.
The European Council and Parliament need to ratify the agreement with a vote expected in November. Full regulation is expected to come in November 2012.
