Merkel, Sarkozy seek EU ban on naked short selling, CDS

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In the clearest signal to financial speculators yet, the French and German leaders, Nicolas Sarkozy and Angela Merkel, heaped pressure on the European Commission to consider an EU-wide ban on naked short-selling and credit default swaps (CDS) on sovereign bonds. 

In a joint letter, Merkel and Sarkozy encouraged the European Commission to consider an EU-wide "prohibition of naked short-selling of all or certain shares and sovereign bonds as well as of all or certain naked sovereign CDS".

"The return of high market volatility raises some legitimate questions, specifically concerning certain financial techniques and the use of certain derivative products, as, for example, short selling and credit default swaps," the leaders said in the letter, addressed to José Manuel Barroso, president of the European Commission.

The two leaders are piling on the pressure to clamp down on speculation in markets, especially on sovereign bonds, ahead of the next round of G20 talks at the end of June and ahead of July talks between finance ministers in Brussels.

The European Commission released a statement today welcoming the letter, saying that it reinforced the push for quick adoption of financial market reform.

"We trust that the political dynamic expressed in the letter translates into full support for swift adoption of our proposals in the legislative process," said Commission spokeswoman Pia Ahrenkilde Hansen. 

In naked short-selling, a trader sells a stock or a bond – betting that it will fall – without owning it or ensuring that it can be borrowed, as would be necessary in a conventional short sale.

A naked CDS contract is typically a bet taken by investment firms like hedge funds that the bond's issuer will end up in trouble.

Both financial instruments have come under fire for building up systemic risk in the wider economy and giving speculators a way of profiting from downgrades of sovereign debt in the EU.

The ministers echoed a call they made in March, alongside Greece and Luxembourg, to limit or even ban naked CDS contracts (EURACTIV 02/03/10).

Today's letter comes one month after Germany became the first European country to ban naked short-selling in shares of the country's 10 most important financial institutions, a move widely depicted as pandering to domestic tensions in the run up to elections.

At the time, French Finance Minister Christine Lagarde admitted she was not aware that Germany was planning an outright ban and later denounced Germany's unilateral move. 

The EU's internal market commissioner, Michel Barnier, also appeared to be wrongfooted by the move and called for greater unity in financial reform.

"It is important that member states act together and that we design a European regime to avoid regulatory arbitrage and fragmentation both within the EU and globally," Barnier said, reacting to the German ban.

Barnier said separate EU proposals to curb naked selling and credit default swaps were in the pipeline and should be ready for discussion by EU legislators before the end of 2010. 

The European Commission said on 9 March it would consider banning 'naked' selling of derivatives contracts and Greece said curbs on speculators would be examined by the G20 powers (EURACTIV 10/03/10).

The measure was prompted by the dire economic situation of EU member Greece.

Commission President José Manuel Barroso said the EU executive would like the G20 to discuss speculation in credit default swaps (CDS), a form of insurance against default.

Some EU politicians accuse speculators of using these complex financial instruments to bet on a Greek bond default.

So-called 'naked' selling involves selling a CDS to a buyer who does not hold the underlying sovereign bond. A naked CDS contract is typically a bet taken by investment firms like hedge funds that the bond's issuer will end up in trouble.

On 19 May, Germany became the first European country to ban naked short-selling in shares of the country's 10 most important financial institutions.

  • 26-27 July: G20 leaders meet in Toronto, Canada.
  • Autumn 2010: EU proposals on naked short-selling and CDS expected.
  • July: EU finance ministers meet in Brussels to discuss financial reform.

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