Financial Regulatory Forum

EU to discuss credit default swap speculation, watchdog frets

By Reuters Staff
March 8, 2010

By Huw Jones and Krista Hughes

LONDON/BASEL, Switzerland, March 8 (Reuters) – European Union finance ministers will discuss next week how to dampen speculation on sovereign credit default swap markets, sources said, as central bankers worry some selling practices pose wider risks.

Greek debt has come under pressure as the country seeks to tackle a ballooning deficit and some politicians say speculators using CDSs, intended to insure against any risk of debt defaults, are amplifying the country’s problems.

“The European Commission may bring forward an initiative at the 16 March Ecofin,” an EU diplomat said.

A senior trading official expects the Commission to say it is studying CDS trading rather than bringing in an immediate ban on “naked” selling of CDS, where the buyer of a contract does not own any of the underlying asset it insures.

Financial Stability Board Chairman, Mario Draghi, said greater regulation would be the natural outcome.

“This way of betting has systemic implications. The sense I have is that governments are increasingly uneasy with this,” Draghi told a news conference after meetings at the Bank for International Settlements in Basel.

German Chancellor Angela Merkel said the EU must act to make CDS more transparent but cannot ban them. She called for international harmonisation, which is already on the agenda of the G20 countries.

The FSB, which is coordinating the G20′s response to the financial crisis, said it was too early to say what sort of dampening mechanism would be used.

“Whenever something has systemic implications, you can bet it is going to get systemic regulation … It’s very unlikely that these markets will be left in the same state as they were before the crisis,” Draghi added.

Greek Prime Minister George Papandreou said on Sunday that France, Germany and Eurogroup Chairman, Jean-Claude Juncker, were ready to announce measures to tackle market speculators abusing CDS in the next few days.

Britain is the EU’s biggest CDS centre and a bloc-wide initiative from the Commission — as opposed to one from euro zone countries — would likely have a bigger impact.

New York is also a major centre but so far the United States has not flagged plans to crack down on naked selling.

The lack of transparency of CDS trading alarmed regulators after toxic CDS contracts played a role in the near demise of U.S. insurer AIG.

Industry officials say the CDS market simply reflects rather than creates problems for sovereign debt holders and issuers.

“A ban on CDS won’t solve the problem — it will spread the issue to other areas,” Michael Hampden-Turner, a Citi analyst, told Reuters television.

The sector is already under the cosh, however.

The G20 agreed last September that CDS and other derivatives should be centrally cleared where possible by the end of 2012 to cut risk.

EU Internal Market Commissioner, Michel Barnier, is due to present a draft clearing law around July and his officials met supervisors and industry representatives on Friday.

“Market participants asked the Commission not to start levying restrictions on sovereign CDS trading,” the senior trading official said.

“It does look like the Commission is under pressure from France to at least engage in a study on the market,” the official said.

European Central Bank President Jean-Claude Trichet, also in Basel, said central bankers did not discuss a ban on CDS trading but other steps could be taken.

“On CDS, I would say that there was absolutely no discussion to prevent them from utilising or engaging in any kind of interdiction,” Trichet told a news conference in Basel.

“There was the sentiment that it could be good that we would have central counterparties and that it would be a certain way to permit the market to function in a secure way and perhaps in a more stable way,” Trichet said.

(Additional reporting by Alex Chambers in London and John O’Donnell in Brussels; editing by John Stonestreet/Ruth Pitchford)

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