Hedge fund body urges restraint on shorting bans

The hedge fund industry’s trade body today warned EU policymakers of the potential impact of restricting short positions in sovereign debt taken through credit default swaps.

The Alternative Investment Management Association (AIMA) said curbing so-called ‘naked shorting’ of sovereign debt would “affect the efficient functioning of global debt markets and have far reaching and substantial negative consequences.”

Andrew Baker, 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.”

His warning came as the European Parliament’s Economic and Monetary Affairs Committee today votes on restricting managers from taking ‘naked’ short positions in sovereign debt, via instruments known as credit default swaps.

The EC has proposed banning shorting sovereign debt markets where sellers have not first borrowed the debt to sell as part of the trade. National regulators fear this can cause mispricing and, in extreme cases, downwards price spirals, the EC says.

Its proposed ban would apply to shorting debt via CDS if the short seller does not simultaneously hold long positions in that debt.

But Baker said: “There should be recognition of the fact that 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.”

Regulators in Greece and Germany moved to curb naked shorting sovereign debt since the crisis.

Baker said: “Ever since, the data coming out of the EC, the German central bank as well as a great number of academic sources shows there is no evidence of market failure in the CDS markets, let alone any evidence that those who bought protection without owning the underlying bonds were somehow pushing down the prices of sovereign debt.”

Aima’s director of policy and government affairs, Jiří Król added: “Regulation should not prescribe the reasons why one may wish to enter into a particular derivatives contract.”

Brussels’ proposal forms part of broader plans, including curbing naked short sales of EU equities, and forcing public disclosure where shorts exceed 0.5% of a company’s shares.

David Williams, partner at lawyers DLA Piper, said: “I have yet to hear a serious argument demonstrating tangible benefits of public disclosure over private disclosure to the regulator. Public disclosure of the holdings of an identified investor opens the investor to the risk of issuer reprisals, to abusive squeezes and to strategy replication.”

Rob Mirsky, head of hedge funds at KPMG, said hedge funds “are not angels of death, they are often looking for strong long trades, not just for shorts, and they can ramp up a long with leverage”.



David Walker

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