20 Oct 2011
Commenting on the EU decision to ban naked sovereign credit default swaps, Professor of Finance at Cass Business School, Ian Marsh, said:
“This ban is based on the accusation that speculating a country will default through trading in credit default swaps actually raises the likelihood of default by increasing the cost of borrowing for the targeted country. There is probably some truth in this accusation, although regulators are taking a risk as there is not much hard evidence to back up their view.
“Banning speculators from buying insurance while allowing hedgers to do so actually favours the people who made the initial mistake - the banks who lent the money - while harming the speculators who pointed out the problem.
“There are parallels with the short sales bans briefly introduced in 2008/09. Then, bank share prices were falling and regulators banned the selling of shares that the seller didn't actually own. These bans were rapidly reversed in most countries as they did not help to stabilise bank share prices. Instead, the short sales bans simply made trading shares by those who did own them less easy and more expensive.
“I expect the same will apply to credit derivatives markets. Banning the speculators will not be costless. Excluding by law a whole bunch of buyers of credit insurance will very likely also reduce the supply of insurance. Legitimate hedgers will then find it harder to get insurance or to reduce their cover should they judge that the situation has improved sufficiently. And I expect that like the short sales bans, this ban on naked buying of credit insurance will also be quickly reversed.
“EU politicians are talking to two audiences as they impose reforms and regulations. The first is their electorate where they want to be seen to be doing something about the crisis. Banning naked CDS writing will seem like a good thing to most of the population. Their other audience is the financial markets who will, I suspect, see this as another instance of the authorities blaming the wrong people and imposing the wrong policies.”
Andrew Shrimpton, member at financial advisory firm Kinetic Partners, on the proposed ban on naked short selling sovereign CDS across the EU:
“The proposed ban on naked short selling sovereign CDS in member states will reduce liquidity in the CDS market, leading to increased volatility of CDS prices, undermine confidence in member state sovereign bonds, and make it more expensive for member states to finance budgets.
This has been demonstrated by similarly ill-timed regulatory tightening such as the banning by France, Italy, Belgium and Spain of the short selling of financial stocks earlier this year, which undermined confidence in bank stocks, reduced liquidity in the banking system and eventually led to a taxpayer-funded bailout of Dexia.”
Peter Moore, head of regulation and compliance at UK compliance consultancy The IMS Group, response to EU agreement:
“The ban on naked sovereign CDS is not consistent with findings of research commissioned by the European Parliament (which found that a ban would harm market liquidity, impair instrument valuation and could ultimately increase borrowing costs for sovereign states) and with research by the German Bundesbank (which found that the larger cash bond and sovereign CDS markets were reacting to events as opposed to either dictating or distorting them). This makes yesterday’s announcement, described by Michel Barnier, the EU’s financial services chief, as one “which strengthens financial stability” very difficult to comprehend.
“The argument that naked sovereign CDS positions exacerbate strained balance sheets of sovereign states is analogous to the argument that short sellers worsen strained balance sheets of corporates. However, informed analysis shows that such practices are a consequence rather than a cause of the strain meaning that the argument runs the risk of missing the true causes of the strain.
“In conclusion, this is a prohibition of a certain capital market practice introduced upon a disproved perception that the practice created or exacerbated stress, with an opt-out available upon the demonstration of actual stress.
“This should raise concerns about the EU’s decision making processes at a time when so many regulatory provisions are currently being developed by it.
"Harmony on share short selling measures across EU member states is welcomed. The rules in this area, a “maximum harmonisation regulation” which imposes a ceiling on market regulation, will relieve market participants of having to ascertain and keep track of a multitude of short selling measures across 27 member states in order to establish what the different disclosure thresholds are and what issuers may be out of bounds for short sellers from time to time.
"Market participants should also find that publicity and possibly also advance notice on periodic short selling measures should improve substantially, at least compared to the Autumn of 2008. However, the true price of this uniformity may still emerge if the UK finds itself outvoted at a time when the EU is contemplating a uniform response to difficult market conditions. The naked sovereign CDS issue is a tangible example of the UK being outnumbered on regulatory policy."
“This ban is based on the accusation that speculating a country will default through trading in credit default swaps actually raises the likelihood of default by increasing the cost of borrowing for the targeted country. There is probably some truth in this accusation, although regulators are taking a risk as there is not much hard evidence to back up their view.
“Banning speculators from buying insurance while allowing hedgers to do so actually favours the people who made the initial mistake - the banks who lent the money - while harming the speculators who pointed out the problem.
“There are parallels with the short sales bans briefly introduced in 2008/09. Then, bank share prices were falling and regulators banned the selling of shares that the seller didn't actually own. These bans were rapidly reversed in most countries as they did not help to stabilise bank share prices. Instead, the short sales bans simply made trading shares by those who did own them less easy and more expensive.
“I expect the same will apply to credit derivatives markets. Banning the speculators will not be costless. Excluding by law a whole bunch of buyers of credit insurance will very likely also reduce the supply of insurance. Legitimate hedgers will then find it harder to get insurance or to reduce their cover should they judge that the situation has improved sufficiently. And I expect that like the short sales bans, this ban on naked buying of credit insurance will also be quickly reversed.
“EU politicians are talking to two audiences as they impose reforms and regulations. The first is their electorate where they want to be seen to be doing something about the crisis. Banning naked CDS writing will seem like a good thing to most of the population. Their other audience is the financial markets who will, I suspect, see this as another instance of the authorities blaming the wrong people and imposing the wrong policies.”
Andrew Shrimpton, member at financial advisory firm Kinetic Partners, on the proposed ban on naked short selling sovereign CDS across the EU:
“The proposed ban on naked short selling sovereign CDS in member states will reduce liquidity in the CDS market, leading to increased volatility of CDS prices, undermine confidence in member state sovereign bonds, and make it more expensive for member states to finance budgets.
This has been demonstrated by similarly ill-timed regulatory tightening such as the banning by France, Italy, Belgium and Spain of the short selling of financial stocks earlier this year, which undermined confidence in bank stocks, reduced liquidity in the banking system and eventually led to a taxpayer-funded bailout of Dexia.”
Peter Moore, head of regulation and compliance at UK compliance consultancy The IMS Group, response to EU agreement:
“The ban on naked sovereign CDS is not consistent with findings of research commissioned by the European Parliament (which found that a ban would harm market liquidity, impair instrument valuation and could ultimately increase borrowing costs for sovereign states) and with research by the German Bundesbank (which found that the larger cash bond and sovereign CDS markets were reacting to events as opposed to either dictating or distorting them). This makes yesterday’s announcement, described by Michel Barnier, the EU’s financial services chief, as one “which strengthens financial stability” very difficult to comprehend.
“The argument that naked sovereign CDS positions exacerbate strained balance sheets of sovereign states is analogous to the argument that short sellers worsen strained balance sheets of corporates. However, informed analysis shows that such practices are a consequence rather than a cause of the strain meaning that the argument runs the risk of missing the true causes of the strain.
“In conclusion, this is a prohibition of a certain capital market practice introduced upon a disproved perception that the practice created or exacerbated stress, with an opt-out available upon the demonstration of actual stress.
“This should raise concerns about the EU’s decision making processes at a time when so many regulatory provisions are currently being developed by it.
"Harmony on share short selling measures across EU member states is welcomed. The rules in this area, a “maximum harmonisation regulation” which imposes a ceiling on market regulation, will relieve market participants of having to ascertain and keep track of a multitude of short selling measures across 27 member states in order to establish what the different disclosure thresholds are and what issuers may be out of bounds for short sellers from time to time.
"Market participants should also find that publicity and possibly also advance notice on periodic short selling measures should improve substantially, at least compared to the Autumn of 2008. However, the true price of this uniformity may still emerge if the UK finds itself outvoted at a time when the EU is contemplating a uniform response to difficult market conditions. The naked sovereign CDS issue is a tangible example of the UK being outnumbered on regulatory policy."
