French academics add to criticism of EU short ban plans

France’s Edhec Risk Institute has become the latest group to warn the European Parliament of the dangers of banning naked short selling of sovereign debt using credit default swaps.

The business school today published an open letter to Sharon Bowles, chair of the European Parliament’s Economic and Monetary Affairs Committee, and the committee’s rapporteur, Pascal Canfin.

In it, Edhec said the proposed ban posed numerous dangers, and would run up against practical obstacles to its implementation.

Brussels is proposing banning shorting sovereign debt markets in cases where sellers have not first borrowed the debt to sell as part of the ‘short trade’. National regulators fear this activity could cause mispricing and, in extreme cases, downwards price spirals, the EC says.

The veto would stop shorting of sovereign debt if the short seller does not simultaneously hold long positions in that debt.

But Edhec said intermediaries and regulators would be unable to verify long positions the CDS hedge is assumed to cover.

It continued a ban would make it more difficult for countries to manage interest rate risk on their debt actively, because counterparties would be barred from hedging the country risk of interest rate swaps they had entered into.

“Such active management of the yield curve is a major component in the optimisation of the cost of public debt,” Edhec said.

It added that defining ‘naked sales’ too strictly would make it impossible for financiers to hedge the default risk of public or private entities they supported, where those entities did business with sovereign nations.

“At a time when public-private partnerships and private financing of public infrastructure projects are considered one of the drivers of global growth, making it harder to manage country risk may at the very least increase the costs of these partnerships and this financing,” Edhec wrote.

Its voice joins that of hedge fund trade body the Alternative Investment Management Association, which warned EU policymakers earlier this week of other problems linked to their short sale proposals.

Andrew Baker, Aima’s chief executive, said: “Debt markets would be less efficient, liquid and transparent. The cost of borrowing would increase and the availability of credit to borrowers would decrease, with a concomitant negative impact on growth and jobs.”

The European Parliament’s Economic and Monetary Affairs Committee is set to vote on restricting managers from naked debt shorting.

Baker said: “The market cannot function properly without liquidity providers who may enter in and out of the contract without hedging any underlying risk exposure.

“The political positions that stated that sovereign debt woes were caused by, or exacerbated by, activity in CDS markets were taken before any hard evidence became available.”

He said numerous academic studies since refuted any claims naked shorting via CDS triggered or magnified sovereign debt problems.

David Walker

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