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Capital Markets

Regulation: EU comes out against naked CDS shorting

Regulators express shorting reservations; Industry participants say “cause and effect” not established

The impassioned call to ban naked credit default swaps gathered momentum last month when the European Parliament announced that it intended to tackle speculative trading, ostensibly in credit default swaps on sovereign debt. In a speech to European lawmakers, Michael Barnier, the European Union’s internal market commissioner, said he planned to propose rules that would provide a "framework" to cover purely speculative naked short selling. Although no specifics were given, officials in Brussels indicated that a range of possibilities would be considered.

It’s an issue that has been simmering under the surface for much of this year after credit default swaps on Greece began to price in heightened default risk, which Greek authorities blamed for a rise in their funding costs. Greek prime minister George Papandreou lambasted speculators for putting Greece at risk by destabilizing the market for its debt. He said credit default swaps speculation was akin to buying insurance on a neighbour’s house and then burning it down to collect a payout.

It’s no surprise then that German chancellor Angela Merkel and French economy minister Christine Lagarde also called for limits to be placed on CDS trading, given their countries’ implied role as a safety net for Greece should it not be able to refinance its debt.

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