From the August 01, 2011 issue of Futures Magazine • Subscribe!

EU looking to restrict CDSs

Stopping shorts

As fears that the effects of the debt crisis in Greece may migrate to other periphery nations in the Eurozone with battered registers, the European Parliament recently voted to back new rules that would severely restrict trading in credit default swaps (CDSs), including a ban on naked short selling.

"It’s becoming standard protocol in Europe to ban short selling every time there’s a market fall. It happened before in Germany with equities and it’s happening again now that the Greek debt crisis is spilling over into Italy," says Will Rhode, senior analyst at Tabb Group. "The regulatory perspective is to curb short selling to reduce speculative activity and, in turn, the speed and depth of a crash. This is a knee-jerk reaction that has unfolded over the course of the 18-month old Eurozone debt crisis."

The proposed rules, that still need to face parliamentary vote to enact, would require traders to settle their uncovered short positions by the end of each trading day and restrict CDS purchases to owners of related government bonds that are dependent on these bonds.

The rules could impact liquidity in these markets. "The reason trading strategies exist are because people see opportunities as a result of market inefficiencies — in this case, incompetent national economic policy. But while it will undoubtedly reduce liquidity in the credit markets, it won’t stop the crisis from escalating. Only a meaningful, commonly agreed bailout program can do that," Rhode says. "Frankly, it’s a bit like closing the door after the horse has bolted."

So far the vote has been only preliminary to gather majority views to go into discussions, but some lawmakers said a deal could be reached by October.

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