Market-watchers agree ban on naked short selling futile
Published 20/05/2010 | 05:00
The German ban on naked short selling of European bonds was deeply unpopular on markets yesterday, with virtually every market observer believing it to be a futile and politically motivated gesture.
Why futile? Because the clampdown on naked short selling, where investors take a bet on the direction of a government bond without owning the actual bond, is not being observed by the main markets where such trading takes place -- London and New York.
The ban, brought in by German regulator BaFin, only applies to trading in Germany, and German banks that use their foreign subsidiaries for such trading do not appear to be covered.
In fact, apart from German Chancellor Angela Merkel, it was hard to find anyone who was prepared yesterday to speak in favour of the ban. Smaller European countries could actually end up being damaged by the ban, said Citi in a report.
They claim that distinctions between naked short sellers and more conventional investors buying bonds in the normal way are not always clear.
Either way, liquidity on European bond markets is set to be reduced by the German plan. A lot of investors -- not all of them hedge funds -- like to hedge their exposure to European bonds by short selling.
Removing that partial protection is likely to see these funds -- many of them based in the US -- drifting away entirely, thereby hitting smaller countries who need a deep market to fund their exchequers.
Short sellers are reflecting the stresses in the European economy, not causing them, Citi said yesterday.
It is hard to disagree. The short sellers who took bets against Irish lenders like Anglo Irish Bank in 2008 were right to be so bearish and their actions were later justified by the nationalisation of Anglo.
Clearly a lot of investors now believe several European countries have deep-seated budgetary problems, with some countries like Greece dangerously close to defaulting on their debts.
The market is entitled, many would argue, to take a financial bet on whether this happens or not.
Clearly if these European countries cut their deficits and roll over their debts, the short sellers will be sitting on huge losses.
The credit default swap (CDS) market performs a strange function, when the prices are positive about certain countries politicians and economists like to point to them as a reliable form of market sentiment.
But when the CDS prices move against a certain country, politicians and economists call for curbs and more regulation of this market.