Brussels, 12/05/2011 (Agence Europe) - The vast majority of the EU member states agreed on Wednesday 11 May to the most recent compromise deal drafted by the Hungarian Presidency for the new EU regulation on short-selling and derivatives (see EUROPE 10338), believing that new EU rules are required to restrict naked short-selling of sovereign debt on the bond markets where necessary in order to ensure sufficient liquidity.
Despite agreement being reached, the United Kingdom is concerned about the powers the new European Securities Market Authority (ESMA) will be granted. Germany says that the current draft does not go far enough to restrict the hedging of sovereign debt (credit default swaps - CDS). A diplomatic source commented that it was impossible to say at this stage whether the ECOFIN Council of Tuesday 17 May would be able to reach qualified majority agreement on the draft regulation. Once agreement has been reached, the Hungarian Presidency would have a mandate for the negotiations with the European Parliament to try and ensure the regulation is passed in first reading.
Short-selling means buying a financial product and selling it on again before one reaches the payment deadline. The idea is that the price of the product will change in the meantime and one can cash in on the difference when one buys it back later to meet the initial payment deadline. Naked short-selling is when a dealer has not actually borrowed or bought the product in question and therefore has no guarantee that it will actually be available at the point of sale. This form of gambling is said to have facilitated the collapse of the financial markets in 2008, an event that showed how differently the various member states react to naked short-selling.
The member states have agreed to restrict naked short-selling by forcing all dealers to have at least agreed with a third party to identify and reserve the products sold so that they can actually be supplied on the payment date. They have agreed to the initial proposals set out by the Commission, not going as far as the European Parliament committee, which wants the above conditions to be met on the day of the initial sale (see EUROPE 10331).
At the March 2011 ECOFIN Council meeting, a group of countries headed by the United Kingdom and Italy warned of the danger of too many restrictions on naked short-selling on CDS, which could lead to the drying up of cash for government bonds (see EUROPE 10338). The Hungarian Presidency suggests that a national authority could be allowed to temporarily suspend (initially for six months) CDS naked short-selling if bond liquidity falls below a certain level. The Anatolian authority would notify ESMA of its plans in advance and ESMA would have 24 hours to express its opinion. The idea is that the Commission would use a “delegated act” to stipulate how exactly the liquidity thresholds would be calculated.
A diplomat commented that everything hinged on the balance between the scale of the potential restrictions on naked CDS short-selling and the powers ESMA would be given because ESMA would have the power to coordinate and issue restrictions but not to permanently ban naked CDS. In the event of a crisis on the markets, ESMA might be granted the power to suspend sovereign debt CDS deals, for example, but the United Kingdom is not happy about this idea, even though ESMA always has to request the consent of the national authority in question. The Commission feels that the measure would be too restrictive.
The draft Canfin Report at the EP argues for sovereign debt CDS to be restricted to covering bonds of the country in question or CDS whose value bears “close correlation” with sovereign bonds (held by a bank, for example, in the country in question). (M.B./transl.fl)