The EU wants to prevent speculation in this market as it believes this could drive up government borrowing costs. Policymakers are also keen to avoid a credit event on Greek CDS, fearing this could put further pressure on those banks having to pay out.
But these aims could backfire. Some bankers believe rather than lowering borrowing costs, these moves will have the reverse effect and also restrict lending to their banks and companies.
In the wake of the CDS ban, some banks are already pushing alternative strategies that risk driving up government bond yields even further. Last week Citigroup, the leading US bank, recommended selling the bonds of France, Italy and Spain because of the trading ban, while other banks have warned they could unload peripheral bonds if CDS payouts are ruled out on Greece. Last week, Spanish and Italian CDS prices fell, while yields on the debt of these countries rose, a possible indication, according to some market participants, that some funds and banks may be closing out their positions in CDS while selling bonds.
A banker who is responsible for managing risk at a big European institution, says: “If there are not going to be payouts [from CDS] and liquidity dries up because of the trading ban, then we will not be able to use CDS as a hedge. That means not only selling bonds of countries like Italy and pushing up their borrowing costs, but telling our country managers there they will have to restrict loans to companies and businesses.”
The International Monetary Fund warned in a recent report that investors seeking hedges other than CDS could include shorting government bonds, bank equity or simply cutting their exposure. Shorting government bonds is “one option”, says Seamus MacGorain, at JPMorgan. The European Commission, which announced the naked trading ban earlier this month, insists the move will ensure sovereign CDS is used for hedging risk only, the purpose it was designed for.
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