Naked Short-Sellers, Derivatives Traders Face EU Restrictions
By Ben Moshinsky - Sep 15, 2010 5:45 AM ET
Naked short-sales of shares and government bonds would be limited and some over-the-counter derivatives trades forced through clearinghouses, under European Commission proposals to safeguard financial markets.
Frequent traders of some OTC derivatives in Europe will be forced to use central clearinghouses to close sales, while naked short-sellers would be required to submit proof they can access the underlying security to settle a trade designed to profit from falling prices, under two separate initiatives announced in Brussels today.
“In distressed markets, short selling can amplify price falls, leading to disorderly markets and systemic risks,” Michel Barnier, the European Union’s financial services commissioner, said in an e-mailed statement.
The rules on short-selling would bring the EU closer to the stance taken by Germany, where Chancellor Angela Merkel banned some naked short-selling in May. Merkel and French President Nicolas Sarkozy argued that some bets against stocks and government bonds should be banned as the Greek debt crisis made markets more volatile.
The EU bill on derivatives clearing is part of a package of laws to strengthen regulation following the worst financial crisis since the Great Depression. The plan is aimed at limiting losses in the event of a default by a major counterparty.
‘Wild West’
“No financial market can afford to remain a Wild-West territory,” Barnier said. “OTC derivatives have a big impact on the real economy, from mortgages to food prices.”
The commission, the executive arm of the 27-nation EU, announced the proposals for discussion by the European Parliament and member states. U.S. and European regulators are pushing for tighter oversight of the $605 trillion over-the- counter derivatives market.
The proposed law on short-selling would require traders to notify authorities of any short position exceeding 0.2 percent of issued capital, and tell the market of positions exceeding 0.5 percent.
The rules also give regulators emergency powers to require more disclosure or temporarily ban short selling and credit- default swaps.
‘Therapeutic Effect’
“These proposals will have a very therapeutic effect,” said Michael Greenberger, a professor at the University of Maryland School of Law, said in a telephone interview earlier this week. “The problems speculators pose in markets far outweigh concerns about liquidity and financial costs. We have had too many systems without costs that have had a calamitous effect on our financial system.”
In the U.S., regulators and Congress rejected a proposed ban on naked swaps last year, with House Financial Services Committee Chairman Barney Frank saying “there was concern that a broad grant to ban abusive swaps would be unsettling,” and U.S. Treasury Secretary Timothy F. Geithner saying he doesn’t think such a measure would have merit.
Short sellers borrow assets and sell them, betting the price will fall, buying them later and pocketing the difference. In naked short-selling, traders never borrow the assets, so betting is unlimited.
Credit-default swaps are derivatives that pay the buyer face value if a borrower -- a country or a company -- defaults. In exchange, the swap seller gets the underlying securities or the cash equivalent. Traders in naked credit-default swaps buy insurance on bonds they don’t own.
Data Bank
The rules on OTC derivatives would force traders to record contracts with a central data bank known as a trade repository, and hand powers to European regulators to decide what type of derivatives must be cleared by a central counterparty.
A derivative is a contract between two parties linked to the future value or status of the underlying asset to which it refers, such as the development of interest rates or of a currency. An OTC derivative is one privately negotiated between two parties, rather than being traded on an exchange.
Clearinghouses operate as central counterparties for every buy and sell order executed by their members, who post collateral, reducing the risk that a trader defaults on a deal.
By Ben Moshinsky - Sep 15, 2010 5:45 AM ET
Naked short-sales of shares and government bonds would be limited and some over-the-counter derivatives trades forced through clearinghouses, under European Commission proposals to safeguard financial markets.
Frequent traders of some OTC derivatives in Europe will be forced to use central clearinghouses to close sales, while naked short-sellers would be required to submit proof they can access the underlying security to settle a trade designed to profit from falling prices, under two separate initiatives announced in Brussels today.
“In distressed markets, short selling can amplify price falls, leading to disorderly markets and systemic risks,” Michel Barnier, the European Union’s financial services commissioner, said in an e-mailed statement.
The rules on short-selling would bring the EU closer to the stance taken by Germany, where Chancellor Angela Merkel banned some naked short-selling in May. Merkel and French President Nicolas Sarkozy argued that some bets against stocks and government bonds should be banned as the Greek debt crisis made markets more volatile.
The EU bill on derivatives clearing is part of a package of laws to strengthen regulation following the worst financial crisis since the Great Depression. The plan is aimed at limiting losses in the event of a default by a major counterparty.
‘Wild West’
“No financial market can afford to remain a Wild-West territory,” Barnier said. “OTC derivatives have a big impact on the real economy, from mortgages to food prices.”
The commission, the executive arm of the 27-nation EU, announced the proposals for discussion by the European Parliament and member states. U.S. and European regulators are pushing for tighter oversight of the $605 trillion over-the- counter derivatives market.
The proposed law on short-selling would require traders to notify authorities of any short position exceeding 0.2 percent of issued capital, and tell the market of positions exceeding 0.5 percent.
The rules also give regulators emergency powers to require more disclosure or temporarily ban short selling and credit- default swaps.
‘Therapeutic Effect’
“These proposals will have a very therapeutic effect,” said Michael Greenberger, a professor at the University of Maryland School of Law, said in a telephone interview earlier this week. “The problems speculators pose in markets far outweigh concerns about liquidity and financial costs. We have had too many systems without costs that have had a calamitous effect on our financial system.”
In the U.S., regulators and Congress rejected a proposed ban on naked swaps last year, with House Financial Services Committee Chairman Barney Frank saying “there was concern that a broad grant to ban abusive swaps would be unsettling,” and U.S. Treasury Secretary Timothy F. Geithner saying he doesn’t think such a measure would have merit.
Short sellers borrow assets and sell them, betting the price will fall, buying them later and pocketing the difference. In naked short-selling, traders never borrow the assets, so betting is unlimited.
Credit-default swaps are derivatives that pay the buyer face value if a borrower -- a country or a company -- defaults. In exchange, the swap seller gets the underlying securities or the cash equivalent. Traders in naked credit-default swaps buy insurance on bonds they don’t own.
Data Bank
The rules on OTC derivatives would force traders to record contracts with a central data bank known as a trade repository, and hand powers to European regulators to decide what type of derivatives must be cleared by a central counterparty.
A derivative is a contract between two parties linked to the future value or status of the underlying asset to which it refers, such as the development of interest rates or of a currency. An OTC derivative is one privately negotiated between two parties, rather than being traded on an exchange.
Clearinghouses operate as central counterparties for every buy and sell order executed by their members, who post collateral, reducing the risk that a trader defaults on a deal.