Progress report
An assessment of hedge fund YTD performance in the face of renewed fears for a potential eurozone crash Read More
26/10/2011
Comment: Andrew Baker
Andrew Baker is CEO of Aima, the Alternative Investment Management Association
You may have heard that the European Council, the European Parliament and the European Commission agreed last week to prohibit the buying of uncovered credit default swaps (CDS) on sovereign debt throughout the European Union.
The ban, which will apply to new contracts from 1 November 2012, is the second significant restriction to short-selling in Europe in the last two months, following the decision of France, Italy, Spain and Belgium to prohibit shorting of the equity of more than 50 financial firms in August – temporary measures that remain ongoing.
Our concerns about the impact of these various bans are by now probably well known. To summarise, we believe that they reduce liquidity and increase volatility, while restrictions on uncovered sovereign CDS specifically will increase government borrowing costs and will reduce real economy investments.
We have not been alone in expressing such doubts. What all these different prohibitions have in common is that they were approved despite credible, independent research recommending the opposite policy approach, some of it commissioned or produced by the same authorities that went on to approve the bans.
However, the temptation has proved irresistible for EU policymakers grappling with the sovereign debt crisis. Once again, this decision was reached despite a mounting pile of independent evidence warning about its negative consequences. The most significant evidence was a report commissioned by the European Parliament itself which stated: “Prohibiting uncovered CDS transactions, as proposed, would have detrimental effects on liquidity.” The European Commission and research by the German Bundesbank have also reached the same conclusion.
Now that the EU ban on uncovered sovereign CDS has been agreed, it is worth reminding ourselves what this debate is all about. The allegation was, at the start of the Greek debt crisis, that the very small Greek sovereign CDS market (only about $10bn in nominal size) was somehow driving the much bigger underlying bond market (some $400bn in size), and so the tail was supposedly wagging the metaphorical dog. Optically, you can see why this conclusion might have been drawn. Movement in the small sovereign CDS market would then be followed by movement in the much larger bond market. Surely the former was pushing the latter?
In fact, what the Commission and the Bundesbank found was that both markets (cash bonds and sovereign CDS) were reacting to events. The sovereign CDS market was not causing the sovereign cash bond market to move; bond markets and the CDS markets were reacting to events, such as announcements by the Greek government about public debt. The markets were not pushing themselves around; they were reacting, as markets do, to news.
Much has been made about the two concessions offered by the European Parliament, reportedly in order to reach agreement with the European Council, which initially was firmly against a ban on uncovered sovereign CDS. But these were minor compromises at best. The first, to allow member states to opt out of the ban, will only apply if the opting-out state can demonstrate to the European Securities and Markets Authority (Esma) that the ban is causing distress in sovereign debt markets. The second concession – to allow sovereign CDS to be used when hedging an investment in an asset whose value is correlated to the price of cash government bonds in that state - would make investments in illiquid assets like infrastructure difficult to do in practice and may even prevent investments that would have been beneficial to the local economy.
At a time when the sovereign debt crisis is gripping Europe and threatening to destabilise the global economy, and amid real concerns about the viability of parts of the European banking sector, European policymakers are taking steps that will make the financial markets less efficient, less transparent and more volatile. That is no way to deal with the most pressing set of policy challenges in living memory.
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60 seconds with... Kenneth Turchin
CAN YOU DESCRIBE YOUR CURRENT ROLE?
I have worked in public accounting and hedge funds and in the past eight years have been selling middle- and back-office services to the alternate investment industry. My role is to build relationships with clients, teach them about SS&C’s products and services, and ensure seamless transactions every time the firm launches a new fund.
IF YOU WERE DOWN TO YOUR LAST £1,000, HOW WOULD YOU INVEST IT?
I would buy THREE shares in Apple and hope for a repeat 383% return in the next five years.
WHAT WOULD YOU DO IF YOU WERE IN PRESIDENT OBAMA’S SHOES?
That’s one pair of size 12 shoes I do not want to be in!
WHO WOULD PLAY YOU IF THEY MADE A MOVIE ABOUT YOUR FIRM?
Kevin Bacon. He is a versatile actor and the centre of the entertainment universe. I am in sales. Everyone in the industry would be linked to me in six steps or less. My client list would be ridiculous.
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