Will Wainewright

26/10/2011 Author: Will Wainewright

EU's CDS shorting ban will not help debt crisis

The ability of European policymakers to agree on anything may have been doubted in recent weeks, but when it comes to banning things the regulators in Brussels are still, it seems, in decisive mood.

The short-selling of sovereign credit default swaps (CDS) is the latest financial practice to face the axe after member states and the European Parliament agreed to measures that will prevent straight betting on CDS.

As with so much new regulation affecting hedge funds, the reasoning is nebulous.

Single market commissioner Michel Barnier, who admits short-selling did not cause the financial crisis, talks of how the practice can aggravate price declines, but the rationale is hardly convincing given the scale of the action being taken – especially when you consider its likely negative consequences.

And there are a few of those.

“The proposed ban on naked short-selling sovereign CDS in member states will reduce liquidity in the CDS market leading to increased volatility of CDS prices, undermine confidence in member state sovereign bonds, and make it more expensive for member states to finance budgets,” points out Andrew Shrimpton of Kinetic Partners.

The market as a whole will suffer, explaining the loophole which allows the trades to continue if the ban causes market failure.

That exemption will be a silver lining of sorts for opponents like the UK, but the move nonetheless represents another Brussels broadside on an embattled industry.

What’s more, there appears little chance of respite, as Man Group’s Luke Ellis said on Monday: “Each day brings new potential regulation for the industry.”

He called regulation “something politicians love to do.”

How hedge funds must wish they didn’t.

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