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Euro-Parliament bans 'naked' credit default swaps

16 November 2011, 16:58 CET
Euro-Parliament bans 'naked' credit default swaps

European Parliament

(STRASBOURG) - The European parliament voted on Tuesday to ban "naked" credit default swaps, a controversial financial instrument used by traders to bet on the risk of a country failing to pay off debt.

"For the first time, Europe will ban a financial product used to speculate on a country's debt," Green group lawmaker Pascal Canfin, a leading negotiator for the legislation, told the parliament before the vote.

"This rule will make it impossible to buy CDS' for the sole purpose of speculating on a country's default," the French MEP said.

Naked CDS instruments will be prohibited in the 27-nation European Union from December 1 under the rules adopted by an overwhelming majority, with 507 of 641 lawmakers present voting in favour.

The lawmakers also backed restrictions on the practice of short-selling company stocks from 2012. Short selling is defined as when a trader borrows shares that he expects to see fall, sells them, then buys them back when the price is lower to allow him to take a profit before settling the loan.

The parliament reached a deal with EU governments last month after long negotiations on banning naked CDS instruments, which were partly blamed for exacerbating Europe's debt crisis.

A CDS serves as an insurance against the risk of default by a company or a government. In a "naked" CDS, the investors do not own the debt, betting they can purchase it later at a cheaper price if a default occurs.

Critics say "naked" CDS allow markets to speculate on a government's chances of defaulting -- something Greece has struggled to fend off since May 2010 -- driving up pressure on such countries.

"It is only logical that CDS' on government bonds are meant for investors who actually have the respective government bonds," said Markus Ferber, member of the conservative European People's Party, the parliament's biggest group.

"All else is pure market speculation that can have incalculable effects, as in the case of Greece, and ought to, therefore, be contained. We need the new provisions to fight the sovereign debt crisis in the eurozone," he said.

The European Commission presented new rules to better control CDS instruments in September 2010 at the request of French President Nicolas Sarkozy and German Chancellor Angela Merkel.

The European parliament had voted to ban "naked" CDS on sovereign debt in July but some states including Italy were opposed, fearing that it would make it more difficult to borrow money.

A compromise was reached in the subsequent negotiations, allowing a national authority to lift the ban for up to 12 months if its sovereign debt market is no longer functioning properly, and possibly extend the decision by six months.

Within 24 hours of a country lifting the ban, the European Securities and Markets Authority (ESMA) would issue an opinion on its website on whether the move is justified.

The Council of EU states is expected to formally approve the new regulation in the coming weeks.

Further information

Adopted text will be available on the European Parliament website (click on 15.11.2011)

FAQ on the regulation (Commission document)

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