At the outbreak of the Eurozone’s debt crisis in early 2010, numerous experts and politicians called for a ban on certain speculative trading activities. In particular, a reference was made to banning naked short sales and uncovered credit default swaps (CDS) because of their direct and significant impact in the destabilisation of financial markets.
When trading in naked (or uncovered) short sales, a price decline in a security that is neither owned nor borrowed, is the subject of speculation. Among others, the collapse of Lehman Brothers was triggered by exactly such speculative activities.
CDS are bought as an insurance against losses that may occur on loans, for example on sovereign bonds. Hence, it is possible to buy CDS without owning an underlying security. Thus, nothing is insured and a gamble is made on a debt default. In this case, we talk about naked (or uncovered) CDS.
EU-legislation dealing with sovereign debts is about to see the light of the day: the Regulation on Short Selling and certain aspects of Credit Defaults Swaps, of which I am the responsible S&D Shadow-rapporteur in the European Parliament.
The aim of this regulation is a least threefold.
Until now, regulators were powerless to establish a full picture of all trading activities, especially of uncovered trades and of short sales. A lack of disclosure requirements means that regulators are unable to properly assess potential risks and dangers. Improving transparency and shedding light to this opaque side of the financial markets is therefore a first necessity.
Secondly, the recently created European Securities and Markets Authority (ESMA) must not be hampered in using its newly acquired powers. Next to ensuring a good coordination between national regulators, ESMA, in order to avoid regulatory arbitrage, must be able to intervene and impose measures at Union level if required.
Most importantly however, speculative activities must be forbidden. There is neither a social nor an economic gain for the real economy of our societies justifying the trade in financial instruments without possession. In fact, holding an uncovered position is the same as insuring your neighbour’s house. Surely you would be tempted to set fire to your neighbour’s house and pocket the indemnity for damage.
The large majority in the European Parliament agrees that no rationale allows for naked short sales and naked CDS to persist. Regrettably a few Member States in the Council buy the arguments of the industry.
They consider that liquidity of financial markets is sacred and that a ban would only dry out markets. But, as they also proclaim that most activities are linked to hedging purposes, would the impact of a ban of purely speculative trades thus not be rather insignificant?
They also claim that the CDS market is too small to influence the price of sovereign debts. Indeed, the CDS market is small compared to outstanding sovereign debts but this does not stop investment banks and hedge funds to trigger large price effects by small trades when they act in concert.
Financial actors defending the status quo are dishonest. They pretend that no evidence supports a ban on certain financial instruments. Quite the opposite is the case. No evidence points to a social or economical benefit of naked short sales and uncovered CDS for the real economy.
Creating instruments that allow the buying and the selling of securities not owned is a phenomenon nowhere to be found in any other part of our economy. European politicians should show guts, stop the diktat by financial markets over politics and ban such speculative uncovered trades for the good of the long-term stability of the European economy.
Tags: CDS, Marchés financiers, Régulation
