The European Union will ban "naked" or uncovered credit default swaps (CDS) to curb what some policymakers see as hedge funds bets on the euro zone crisis, two EU sources said today.
The measure has been deadlocked for months because of a split between the European Parliament and EU states, who have joint say. Both sides meet today with a news conference scheduled for later.
"The final point of negotiation relates to the ban on naked sovereign credit default swaps (CDS), those used for a purely speculative aim," said Pascal Canfin, the French Green Party member who is leading the parliamentary team.
Parliament has already voted to ban CDS contracts, a form of insurance against default, where the holder does not own any of the underlying government debt being insured.
But European Union states have said this is a step too far and proposed curbing short-selling of the government debt itself, and only if the country in question agrees.
Two sources familiar with the negotiations said a compromise has been reached to ban naked sovereign credit default swaps but allow individual EU states to opt out if they think their sovereign debt market risks being damaged.
"The negotiations will be on the fine tuning, the exact scope of the ban and the conditions of the opt out," one of the sources said on condition of anonymity.
Member states would be able to opt out on the first signs their debt market was not working properly, with Britain alone in saying this was still too restrictive, a second EU source said.
Policymakers accused hedge funds last year of using CDS contracts to bet on a Greek default, a step they said made it more expensive for the EU to rescue Greece. It prompted French president Nicolas Sarkozy and German chancellor Angela Merkel to call for the draft law.
But a study for the European Parliament said a ban on naked CDS would have "detrimental effects on liquidity and the price discovery process of credit risk".
Hedge funds say the CDS market is too small to manipulate the far bigger sovereign debt market and that government bond prices have tumbled in Greece and elsewhere in the euro zone because of investor worries over the level of public debt.
The measure aims to avoid a repeat of confusing unilateral national curbs on short-selling in financial shares in 2008 after the collapse of US bank Lehman Brothers.
Italy, Spain, France, Belgium and Greece reintroduced short-selling curbs this summer while other EU states like Britain refused to join in.
Such curbs are disputed by exchanges and some academics, and failed this summer to stop a rout in French banking shares as the euro zone crisis sent investors scurrying.
The European Securities and Markets Authority would have powers to override national supervisors and impose temporary pan-EU share short-selling bans in times of market turmoil.
The new law will also impose reporting requirements on short positions in shares and sovereign debt.
Shorting stocks would only be allowed if prior arrangements have been made to borrow the stock to ensure prompt settlement of trades or that there is reasonable certainty the stock will be available.
