17 October 2011

FN: Italian volte-face raises prospect of naked CDS ban

This marks a 180-degree turnaround from its previous stance and makes the prospect of an outright ban throughout the European Union much more likely.

Hitherto, Italy had opposed a ban, proposed by Germany and backed by the European Parliament. Its change of heart seems likely to change the balance of power in that chamber and give those backing a ban a majority. Italy had always thought a ban on CDS would alarm the market and only add to its borrowing costs but, with its sovereign five-year CDS prices trading above 500 basis points in late September, Italian lawmakers seem to have decided that things cannot get much worse and that the nearest scapegoat needs to be blamed.

A report commissioned by the European Parliament, produced by the German Centre for European Economic Research, considered the impact of various regulatory initiatives under consideration, and concluded that a ban on naked CDS trading would have “detrimental effects on liquidity and the price discovery process of credit risk”. Indeed, it also noted that a “significant deterioration of market liquidity was found to result from the temporary short-selling bans imposed in September 2008”. It also noted not all naked CDS trades are speculative and reminded the European Parliament that a study conducted last year by the European Commission provided “no conclusive evidence for a link between developments on the CDS market and higher funding costs for states”.

Final conditions for a ban of naked CDS have yet to be determined, and will undoubtedly involve more wrangling. The rules are likely to incorporate circumstances whereby a country might opt out of the ban – but perhaps the banks should not wish for too much here. “We will not support a ban on paper and an opt-out in practice”, French Green MEP Pascal Canfin, the rapporteur for the proposed legislation and a long-time opponent of the CDS market, said recently.

Full article (FN subscription needed)

© Financial News