ANALYSIS-Europe won’t go as far as Germany on CDS, bonds

By Reuters Staff
May 19, 2010

By Huw Jones and John O’Donnell

LONDON/BRUSSELS, May 19 (Reuters) – The European Union, struggling to calm volatile financial markets, intends to curb speculation in government debt but remains very unlikely to imitate harsh steps announced by Germany.

The difficulty of enforcing any prohibition on speculative trade, and concern that any ban might backfire by depriving investors of ways to hedge their risks, mean many governments are reluctant to try to introduce regional or global bans.

Instead, the EU is likely to focus on increasing transparency in the markets — forcing traders to disclose more information about their activities, so that regulators can see risks emerging — and on introducing limits to the size of derivatives positions which traders can hold.

“There are philosophical differences between banning and regulation and there are many underlying corporate uses of CDS makets for hedging purposes,” said Avinash Persaud, a member of the United Nations Commission of Experts on International Financial Reform.

“So I think there will be a couple of countries that will find it hard to ban it.”

Germany announced on Tuesday that it was banning naked short-selling of shares in its 10 top financial institutions, naked short sales of euro zone government bonds, and naked transactions in credit default swaps (CDS) linked to the debt of euro zone states.

In naked short-selling, a trader sells an instrument short, betting its price will fall, without first borrowing the instrument or ensuring it can be borrowed, as would be done in a conventional short sale. Naked trade in CDS, which insure against debt defaults, does not hedge an underlying asset.

Germany’s ban on short-selling of bank shares is not very controversial; some other continental European countries, including France, introduced such curbs during the global financial crisis and still have them.

Top officials around Europe want to intimidate hedge funds and other speculative traders, and to discourage certain types of trade for fear they could help to push up bond yields, preventing weak states from financing themselves in the market.

“We intend to deal with this matter very severely,” the EU’s top financial services regulator, Michel Barnier, said of CDS speculators on Monday.

“These people don’t like to come out in the light of day. We are going to flood them with light.”

In July, Barnier is due to present a draft law on regulating the derivatives sector to EU states. He has also said that in October, he will present a separate proposal to introduce more transparency and disclosure into CDS trade.

BONDS

But the reactions of other European states to Germany’s initiative on Wednesday showed they were far from following its lead, and indeed were annoyed that Germany had acted without consulting them.

French Economy Minister Christine Lagarde, who in the past has been eager to join German criticism of speculators, said she regretted Germany’s unilateral decision, and that naked short-selling of European debt was actually useful in providing liquidity in the bond market.

“It seems to me that one ought to at least seek the advice of the other member states concerned by this measure,” she said. “Therefore we are not considering doing it…we are not considering following those measures.” [ID:nPAB008358]

Barnier did not say whether he approved of the idea of German-style bans but indirectly criticised Germany for not coordinating its action.

“It is important that member states act together and that we design a European regime to avoid regulatory arbitrage and fragmentation both with the EU and globally.”

Finland, Sweden, Belgium, the Netherlands and Austria also said they had no plans for German-style bans.

Britain’s Financial Services Authority, which regulates Europe’s biggest derivatives trading centre, said merely that Germany’s decision would not apply to branches of German banks such as Deutsche Bank in the United Kingdom.

One European Treasury official, who declined to be named, told Reuters that Germany’s ruling coalition, which lost an important local election earlier this month, might be acting to impress a domestic political audience.

Suspicion that Germany’s move might be a political gesture, rather than a considered response to market volatility, were fuelled by the fact that German regulator Bafin, which will enforce the ban, said as recently as March that it saw no evidence of major speculation in CDS.

PRAGMATISM

Although many EU governments sympathise with Germany’s concerns, they are pragmatic in recognising that unless bans are applied globally, they are unlikely to be effective in borderless financial markets; trading can simply shift to less regulated jurisidictions.

Also, some officials see Germany’s ban as a distraction from the need to address Europe’s debt crisis by cutting budget deficits — while the ban could worsen market volatility by smacking of desperation on the part of policy makers.

“What we have to do now is to consolidate the budget deficits credibly — the CDS discussion is a sideshow,” an Austrian finance ministry spokesman said on Wednesday.

The European Treasury official suggested that in addition to domestic politics, Germany might be trying to set the agenda for meetings in June of the Group of Twenty major nations, which will deal with global regulation among other issues.

On Thursday, Berlin will host a meeting at which EU governments will discuss their preparations for the G20 talks. But the G20 is also unlikely to agree to any blanket ban on naked short-selling of bonds or CDS trade.

The group agreed last year that derivatives should be regulated, centrally cleared and have transactions reported to regulators by the end of 2012. But Britain and the United States, where the vast majority of CDS trade occurs, would have most to lose from a ban and have not supported the idea of one.

“I don’t think they will get all the G20 to support it,” said Persaud.

Unilateral regulatory action by Germany or other EU states may become harder in future as the region centralises its financial supervisory powers, by setting up new pan-EU authorities to oversee the securities, insurance and banking industries.

These authorities are expected to be set up next year, and final talks on their structure are underway between the European Parliament and EU states. Barnier called on Wednesday for the talks to be concluded in coming weeks.

(Additional reporting by Boris Groendahl in Vienna, Clara Ferreira-Marques in London, Emmanuel Jarry in Paris, Greg Roumeliotis in Amsterdam and Terhi Kinnuen in Helsinki; Editing by Andrew Torchia)

((+44 207 542 3326; huw.jones@thomsonreuters.com))

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