EU to ban controversial 'naked' credit default swaps
(BRUSSELS) - The European Union decided late Tuesday to ban "naked" credit default swaps, a controversial financial instrument that traders use to bet on a country's failure to pay off debt.
EU states and the European parliament reached a deal after long negotiations to prohibit the highly speculative instrument 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 countries.
"The parliament fought to put an end to speculation on sovereign debts in Europe," said Green member of the European parliament Pascal Canfin.
"The prohibition of naked CDS on sovereign debt is a great victory," said the French lawmaker, who led the charge in parliament against naked CDS.
"Today's compromise will make it impossible for a hedge fund to buy Greek or Italian CDS without already owning the bonds of those countries, for the sole purpose of speculating on the country's default," he added.
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 voted to ban "naked" CDS on sovereign debt in July, but some states including Italy were opposed, fearing that it would increase the price of their bonds and make it more difficult to borrow money.
A compromise was reached allowing a state to not apply the rule for a certain period of time, under a specific set of criteria. The European Securities and Markets Authority (ESMA) would have to be informed of such a decision and decide if it is justified.
The agreement also includes restrictions on short-selling, requiring traders to disclose significant short positions on company shares or government bonds to market regulators.
The ESMA will have the power to temporarily restrict short-selling in exceptional circumstances, such as a steep market drop.
EU internal markets commissioner Michel Barnier hailed the "ambitious accord marking a strengthening of financial stability" and said it was a "signal of European will" ahead of a crucial EU debt crisis summit on Sunday.
The parliament is expected to vote on the legislation in November. It must also be formally adopted by EU states. The regulation would enter into force in November 2012.