14 March 2011

FN: Fears grow over CDS restrictions

Hedge funds, dealers and trade associations voiced their concerns, after European Union lawmakers in the EP voted on Monday to back proposals curbing trading in uncovered sovereign CDS. Policy-makers have argued that naked trading in CDS is speculative and helped to exacerbate last year's European sovereign debt crisis by pushing down gilt prices and weakening countries' debt position. The regulation, which was proposed by the Commission in September last year, aims to limit trading in CDS and in short selling, and is currently being debated in Brussels.

On Monday, the European Parliament voted to back the proposal to clamp down on trading in CDS related to sovereign debt unless the investor has a long position in the underlying debt or an equivalent pool of assets, such as shares in a major company located in that country. The vote indicates that the final rules will be extremely restrictive and has raised alarm among industry participants who argue that trading in naked CDS provides a legitimate means of hedging a wide range of risks associated with a specific country.

Industry associations have argued that the clampdown could reduce liquidity in the overall CDS market which would in turn push up prices. Alex McDonald, chief executive of the Wholesale Markets Brokers Association, said: “Ensuring that there is liquidity in the CDS space is important, so any regulatory move to diminish the CDS market is a poor outcome. It’s a classic case of shooting the messenger because you don’t like the message.”

The International Swaps and Derivatives Association said a reduction in sovereign CDS liquidity could push up the cost of issuing country debt. "If hedging positions with sovereign CDS become more costly, then investors may be less inclined to invest in sovereign debt, ultimately increasing funding costs for Member States.”

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