Sources close to the EU's policymaking process reveal that current thinking on regulating Credit Default Swap (CDS) trading is limited to sovereign not corporate debt.
Regulation, the sources said, would be restricted to "insurable interest," essentially meaning that only those who own the underlying bond can take out insurance on it.
Credit Default Swaps have been in the political limelight since the Greek debt crisis highlighted that the swaps were hiding the true level of the country's budget deficit and allowing markets to bet on Greece defaulting on its debts.
Sony Kapoor of financial think-tank Re-Define believes the European Commission will likely seek to limit CDS trades to around 100% or 125% of insurable interest.
Zsolt Darvas of Brussels-based think-tank Bruegel says this is a sensible idea as it prevents the market from betting on countries' defaulting on their sovereign debts.
Brussels-based diplomats confirm that France and to a lesser extent Germany are putting their full weight behind imposing restrictions on CDS trading, especially on sovereign debt.
Britain has been unusually quiet in the debate on sovereign debt swaps, as the City of London is a prime sovereign debt-swapping location.
British diplomats say the UK is watching the debate with great interest, but believe it is too early to weigh in with a position on the matter.
EU derivatives rules in progress
The European Commission is in the early stages of drafting a proposal on making derivatives trading - which includes CDS trading - more transparent and pushing all Over The Counter (OTC) derivatives through central clearing houses first.
A proposal had been originally earmarked for July this year but this deadline has since been pushed back.
In 2009 the Commission secured an industry commitment to ensure that a substantial part of CDS are cleared by Central Counterparties (CCPs) – risk managers that proved their worth during the crisis.
Interestingly, this agreement did not include sovereign debt swaps.
According to the Commission, an upcoming review of reporting rules in the Markets in Financial Instruments Directive (MiFID) and Market Abuse Directive (MAD) will include OTC derivatives.
The intention, according to a Commission document, is to enable supervisors and regulators, among others, to monitor the market and find out who holds which positions and which derivatives are systemically important.