Brussels, 18/11/2011 (Agence Europe) - Speculation in sovereign debt credit default swaps (CDS) will be virtually banned in the European Union by November 2012. In the evening of Tuesday 18 October, negotiators at the European Parliament and the Polish Presidency reached an interinstitutional agreement in prinpcle on the draft regulation on CDS (see EUROPE 10479), which includes a ban on naked sovereign debt CDS under tight restrictons. Describing the deal as a grand victory of the European Parliament, rapporteur French Green MEP Pascal Canfin says in a press release that the agreement will mean that hedge funds will no longer be able to buy up Greek or Italian CDS without actually owning the bonds against whose default the CDS protects against, thereby preventing said funds from speculating on whether a country will go bankrupt. He said the regulation demonstrated to Europeans that Europe is perfectly capable of taking action against speculation when it sets its mind to it. The two co-legislative European institutions now have to endorse the compromise and the EP is due to vote on the matter in the November plenary so that the rules can come into force a year later.
When they reached basic agreement in May 2011 (see EUROPE 10380), the member states did not include any restrictions on trade in naked sovereign debt CDS. In order to win their agreement, the draft compromise sets out clear conditions for when the ban will apply. Nation states will have the power to temporarily lift the ban if it has a negative impact on the bond markets amidst escalating rises in the cost of rolling over public debt, for example, or if a country finds it difficult to issue new bonds.
Any decision by a national supervisor to end the ban on naked sovereign debt CDS must be based on the following objective circumstances: high or rising interest rates for bonds, an increasing gap in the rates offered for bonds in the two countries (the German Bund is usually used as a reference), and increasing the gap in the price of sovereign debt CDS, the length of time needed for a bond to return to its original balance after serious trading volumes and the actual amount of bonds that can be traded.
In addition, the European Securities Markets Authority (ESMA) will publish an opinion on whether it agrees that the ban on naked CDS should come to an end, and the said opinion will be issued within 24 hours of the national supervisor's decision.
As far as the Polish Presidency is concerned, the compromise has struck a balance mid-way between the views of the Council of Ministers and the European Commission, both of which oppose any restrictions on CDS, and the European Parliament, which encourages a ban on naked CDS despite hostility from the liberals and conservatives, pointing out in a press release that the carefully formulated compromise allows verification and balance. EU Internal Market Commissioner Michel Barnier said the compromise was a welcome improvement on the Commission's initial draft and would ensure sovereign CDS were used for the purposes for which they had been created. The ban will nt cover primary dealers or market makers.
Naked trading. The regulation lays down a series of rules on naked short-selling, accused of exacerbating the financial crisis of 2008. The Polish under-secretary for finance, Wies³aw Szczuka, said that there was nothing wrong in short-selling as such, as it can help markets operate smoothly by providing liquidity and helping set realistic prices. When the regulation comes into force, national supervisors will be able to take much more effective and coordinated action in the event of serious instability on the markets, explained Barnier. to restrict naked short-selling in exceptional circumstances. Canfin welcomes the new powers for ESMA on the stock markets, but regrets that the member states refused to give ESMA the same powers over treasury bonds.
The Polish Presidency said the new rules were an adequate response to the abuse of naked short-selling although, the agreement acts against the wishes of the EP and the Commission by watering down the restrictions on naked selling. The initial idea was that if a seller did not own the security in question, then they needed to have at least struck agreement with a third party to isolate and reserve the security so it is available on clearing date (locate & reserve rule). The MEPs even demanded that the locate and reserve rule had to be in force on the day the deal was struck. The new compromise, however, stipulates that traders must locate the security and show that it can reasonably be expected to be available for loan from an identified party. Barnier believes these rules will reduce the number of transactions that fall through.
Transparency. The new legislation introduces new transparency rules. Traders will have to provide national supervisors and markets with details of their biggest short-term positions (over 0.5% of the securiites emitted). Supervisors will have to be better able to take preventative action and issue early warnings of dangers to financial stability. (MB/transl.fl)