European parliament seals ban on sovereign debt speculation and short selling

The European Parliament voted today into law a regulation to curb short selling and trading in credit default swaps (CDS), a financial product for insuring against default. The rules will impose much more transparency and virtually ban certain CDS trades, thereby making speculation on a country’s default more difficult, the institution announced.

This is one of the key regulations pushed through by the Commission to tackle the financial crisis. Both short selling and CDS trading are accused of having fuelled market volatility, with CDS trades moreover having been widely blamed for potentially aggravating Greece’s troubles.

The parliament obtained a ban on naked CDS trading (purchasing default insurance contracts without owning the related bonds). Purchasing Italian CDS, for example, will now be possible only if the buyer already owns Italian government bonds or a stake in a sector highly dependent on the performance of these bonds, such as an Italian bank.

The sole exception is an option for a national authority to lift the ban for a maximum of 12 months in cases where its sovereign debt market is no longer functioning properly, and then possibly renew it for a further six months. Even this possibility would be closely circumscribed, because the text specifies a limited number of indicators which could justify the regulator’s action. Moreover, within 24 hours, the European Securities and Markets Authority (ESMA) would publish an opinion on its web site as to the utility of suspending the ban. A negative opinion from ESMA would have political weight.

“These rules prove that the EU can act against speculation when the political will is there. This rule will make it impossible to buy CDS for the sole purpose of speculating on a country’s default,” said rapporteur Pascal Canfin.