Brussels, 15/11/2011 (Agence Europe) - By a wide majority on Tuesday 15 November, the European Parliament confirmed the interinstitutional agreement to virtually ban speculation in credit default swaps (CDS) used to hedge against the danger of a country defaulting on its debt (see EUROPE 10477). Pascal Canfin (Greens/EFA), the EP rapporteur, described the vote as a victory for the EP because for the first time since the outbreak of the financial crisis, Europe is banning a financial product, speculation in which is jeopardising the financing of the member states. He said he was sure that the new rules would prevent hedge funds from trading in Greek and Italian CDS unless they actually owned the related bonds and would therefore prevent hedge funds from betting on whether a country was likely to default on its debts. He said the draft regulation on naked short-selling and CDS sent a double signal because ordinary people would understand that Europe is capable of taking action when the political will is there and the financial world would understand that the time for speculating against nation states is over.
Investors will still be able to buy CDS if they own shares in assets which are closely correlated with sovereign debt (rather than having to own the bond as such), such as shares in a major bank of the country in question, and would therefore be able to insure against the risk of Greece, say, defaulting by taking up CDS for the Greek bonds in which they have a share in the form of shares of a Greek bank or blue chip company. Canfin said that this type of proxy hedging would be allowed under the new regulation.
There are strict rules governing the ban on CDS and supervisors may temporarily lift the ban if it is likely to cause a credit crunch for the country in question. For example, if the cost of rolling over a country's debt is rising sharply or if countries are finding it difficult to sell their bonds. The decision to lift the ban would have to be preceded by a range of indicators, like an increase in the spread in the yield compared with German bonds or another country's debt, the time needed for a bond to find its level when large volumes are traded. The European Securities and Markets Authority (ESMA) will have 24 hours to issue an opinion on whether a ban on naked CDS sales should be lifted.
Fears of a credit crunch. Fearing problems with shifting their debt, Spain and Italy took some convincing of the need to ban naked CDS selling, but finally came round to the idea that the ban should protect them, said Canfin, and if the opposite proved the case, they had a button to press to reverse the situation. This opt-out option is one reason why Europe will be the first area in the world to ban CDS. The rapporteur added that after these rules on CDS sales, rules should be introduced to govern the issue of CDS.
MEP Robert Goebbels (S&D, Luxembourg) said the opt-out would force countries to explain why they want to reverse the ban on naked CDS sales. British Liberal Sharon Bowles pointed out that the ban on speculation in CDS would be assessed by ESMA in the immediate future to see whether any changes were needed. Thomas Händel (GUE/NGL, Germany) said that the current rules do not go far enough: “Particularly in view of the Greek crisis, we are seeking an outright ban on naked short selling and credit default swaps. Too many exceptions and opt-outs, difficulties of control, and long intervention phases have watered down efforts to reign in these speculative and highly damaging financial instruments.”
ESMA. ESMA will be able to greatly limit CDS trading in exceptional circumstances. In the event of crisis, ESMA will be able to force national authorities to accept its decisions about shares markets, explained Canfin, who wanted similar powers for sovereign debt but the member states had refused to go along with this. Will the United Kingdom challenge ESMA's new powers at the
European Court of Justice? Sharon Bowles said that was always a risk, but she thought the legislation was manageable.
The new rules will introduce greater transparency because traders will have to provide national supervisors and markets with details of their short-term positions of above 0.5% of the total securities issued. Supervisors should be able to take preventative action and issue warnings about dangers to financial stability. Goebbels was pleased that there was going to be some transparency at last in this very secretive section of the financial world. (MB/transl.fl)