War on Naked Shorts: EU Bans Short Selling

Politicization of the marketplace has been broadening. Trading curbs are not only applied to commodities but to short-selling as well.

From Bloomberg,

The European Union reached a deal as part of a short-selling law that will pave the way for an optional ban on naked credit-default swaps on sovereign debt.

Poland, which holds the rotating presidency of the EU, and lawmakers from the European Parliament reached the accord at a meeting in Brussels yesterday.

Under the deal, traders may be prevented from buying CDS on government bonds unless they either own the sovereign debt or other assets whose price moves in tandem with it. Nations will have the right to opt out of the measure if they detect signs that it may affect their borrowing costs.

“These balanced measures will ensure that sovereign CDS are used for the purpose for which they were designed, hedging against the risk of sovereign default, without putting at risk the proper functioning of sovereign-debt markets,” EU Financial Services Commissioner Michel Barnier said in a statement.

German Finance Minister Wolfgang Schaeuble and lawmakers in the European Parliament have called for a ban on naked CDS trades on government debt over concerns the practice fueled the euro zone’s debt crisis. Germany already has restrictions on using swaps to bet on sovereign defaults.

Some European governments have also criticized the use of short selling to bet against bank stocks, arguing that the practice has roiled markets. Volatility that sent European bank stocks to two-year lows led France, Spain, Belgium and Italy in August to impose temporary bans on short selling that remain in force.

Opt-Out Clause

Under yesterday’s deal, national regulators will be able to suspend the CDS ban in their territory at the first signs that it may harm their sovereign debt market.

The opt out-clause won over some critics of possible bans.

“I never signed up to the belief that a ban on uncovered sovereign CDS would have any positive impact,” Syed Kamall, who represents London in the EU Parliament, said in an e-mailed statement. “However, I’m reassured that member states will have the ability to opt out of the ban, if they see signals that sovereign debt markets are distressed.”

The European Securities and Markets Authority will give a non-binding opinion on whether a national regulators’ decision to drop the ban makes sense. ESMA coordinates the work of national markets regulators in the 27-nation EU.

Renew Indefinitely

While the suspensions will in theory be temporary, regulators will be able to renew them indefinitely. Under the terms of the agreement, existing CDS positions will be grandfathered until they expire.

CDS are instruments that act as insurance for the buyer against losses on bonds. The practice becomes naked when someone buys swaps on debt that they do not actually own.

The measure forms part of a broader agreement on an EU law that will also curb naked short selling of stocks and government bonds.

All these curbs seem like a 'comprehensive strategy' to preserve the status quo

Global governments want to see LOWER commodity prices because this allows them some space to apply more inflationism to uphold political goals when deemed as expedient by the incumbent authorities. Also this allows them to declare victory against ‘inflation’ or to swagger about the success of their policies.

Governments do not want see the public go SHORT on sovereign debt because the welfare state based governments badly desire to maintain their spendthrift -borrow and spend-ways, whose benefits accrue to the political class, their voting constituent groups and their cronies.

Instead governments want HIGHER stock markets, particularly the banking and financial sectors as these institutions hold much of sovereign debt in their balance sheets as Basel mandated ‘risk free’ assets. Remember, banks serve as the PRINCIPAL conduits in the financing of the welfare state.

That’s why a ban on naked shorts, a form of price control, has been designed NOT only to preserve the access to funding by the welfare state, they are meant to keep banking and financial stocks AFLOAT.

Besides for central bankers higher stock markets PROMOTE aggregate demand via more spending (regardless of what kind of spending).

Yet these policies are directed to benefit holders financial assets at the expense of the productive sectors of the economy. Wealth/Income inequality and political inequality anyone?

To add it up: The overall direction of global market interventions has been to promote Bernanke’s doctrine of the wealth effect worldwide and to preserve the welfare state.

The caveat is that all these cumulative actions presumes that market interventions will effectively skew the law of demand supply in their favor—a utopian scenario.

Occupy Wall Street guys, have you been listening?