Germans Restrict CDS and Short Selling

Coming hot on the heels of the EU’s restriction on hedge funds because of the role they played in the financial crisis (though this role was in fact pretty minimal) comes the latest European attempt to deal with nasty financial market participants. The German government has released the following statement, translation thanks to the FT’s Alphaville column:

The Federal Financial Supervisory Authority has on Tuesday temporarily banned naked short sales of debt securities issued by eurozone countries for trading on domestic stock exchanges in the regulated market. It has also temporarily banned so-called credit default swaps (CDS) where the reference bond and liability are from a eurozone country, and which does not serve to hedge against default risk (naked CDS).

In addition, BaFin has banned naked short sales in the following financial sector companies: 











These bans apply from 19 May 2010, 00:00, until 31 March 2011, 24:00, and will be reviewed.

BaFin justifies these steps given extraordinary volatility in debt securities issued by eurozone countries. Furthermore, credit default swaps on the credit default risk of several countries in the eurozone has increased significantly. Against this background, massive short sales of the affected debt securities and the conclusion of naked credit default risk on eurozone countries had led to excessive price shifts, which could have led to significant disadvantages for financial markets and have threatened the stability of the entire financial system.

Faced with these circumstances, BaFin has also banned naked short sales within the selected financial institutions.

The FT notes that “BaFin had previously introduced a ‘transparency system for net short selling positions‘, and found ‘no evidence of massive speculation against Greek bonds‘ in the CDS market.”

Let’s be clear about this. Short sellers are not the cause of the European sovereign debt crisis anymore than they were the cause of the Irish banking crisis.

As an aside, it’s worth noting that this announcement appears to have triggered a pretty serious downward run on the euro. Now I happen to think that this is a good thing in our current economic circumstances but perhaps the “ve must protect ze currency” crowd might remember that much of the demand for the currency comes from people who use it to purchase financial assets. If you keep mucking around with the rules of the games for financial assets denominated in euro, eventually investors pack it in and your currency loses value.

This shouldn’t be too complicated a point to understand. For example, I teach my undergraduates about how a currency’s value depends on the supply and demand for the assets denominated in that currency.

Anglo Stops Payments on Bonds, CDS Implications?

Thanks to Karl D. for the tip-off on this story.  Anglo Irish has announced that it will not be paying coupons on its Tier 1 subordinated bonds and that this decision was required by “The European Commission, as a condition of its approval of the Government’s capitalisation of the Bank of up to €4bn.”  In a related story, the International Swaps and Derivatives Association has decided that a similar non-payment by Bradford and Bingley represents a “credit event” which will trigger CDS insurance.  (Bloomberg story here, official announcement here.)

Presumably, Anglo’s actions will at some point trigger the same decision from the ISDA.  This will mean that those Anglo bondholders holding CDS insurance will receive full payment.  Anglo’s announcement also discusses its “liability management” exercise, in which it is planning to buy back outstanding debt at below par.  Presumably, however, those insured by CDS will no longer be interested in a deal of this sort.  It also makes it likely that much of the debt that Anglo is planning to buy back at a discount will be owned by CDS issuers.

Update: My presumablys were perhaps a bit presumptious.  Commenter Eoin notes below that this is not (yet) a credit event.  I have checked this elsewhere and am informed that the “reference” obligation that defines a credit event for Anglo is indeed a failure to meet Tier 2 obligations.