New EU law will force traders to disclose risky market positions
Brussels moved to curb speculation in EU bond and share markets yesterday by publishing a draft law that forces traders to disclose risky positions and allows regulators to suspend the practice of short-selling.
Short-selling is where traders sell shares they don't own on a bet their price will fall, hoping to buy them back later at a song.
It is considered a legitimate practice for offsetting or hedging risk, but regulators say it can be harmful when false rumours fuel downward pressure on bank shares or government bond prices, calling into question their viability.
During the eurozone debt crisis earlier this year, the European Commission and the Greek government blamed speculators in credit default swaps -- insurance contracts where the buyer gets paid if the underlying company or country goes bust -- for driving up the cost of borrowing for the embattled administration in Athens.
"No financial market can afford to remain a Wild West territory," said internal market chief Michel Barnier after the proposals were released.
"In distressed markets, short selling can amplify price falls, leading to disorderly markets and systemic risks."
The rules -- which could take effect as early as 2012 if agreed by national governments and European parliamentarians -- will hand regulators the clout to ban short-selling for up to three months and curtail certain credit default swap transactions if a future emergency is declared.
Financial market players will have to tell supervisors in their home country if they take excessive short positions against certain companies.
Traders with exposures worth more than 0.2pc of the issued share value in any one company will have to show their hand to regulators, while those with positions above 0.5pc will have to make information public on the market.
The EU executive stopped short of an outright ban on naked short-selling -- where traders don't buy back the bonds on which they're betting -- including instead a complex "locate rule" forcing the seller to prove he has made arrangements to access the shares further down the line.
This leaves an "audit trail" regulators will be entitled to scrutinise if they suspect dodgy transactions.
The commission wants to make sure EU rules are the same across the 27 member states to avoid a repetition of what one official called a "fragmented kaleidoscope" of responses to the recent crisis.
But the London-based Alternative Investment Management Association panned the new powers, saying a ban would prove unworkable.
A second draft law aims to bring the unregulated over-the-counter derivatives market into the open by forcing traders to register their transactions in data centres and settle them through central counterparties (CCPs) or clearing houses.
The rules will also apply to non-financial corporations where they exceed certain yet-to-be-specified exposures, as well as to hedge fund managers, banks, pension and insurance firms.
The idea is that by putting CCPs between buyer and seller, it will limit the risk to the financial system should one of them default.
Any agencies wishing to set themselves up as CCPs will need to have start-up capital of at least €5m, as well as adequate reserves to absorb potential future losses.
Firms that remain outside the new system will face higher costs than their compliant counterparts.