No evidence to support EU ban on naked CDS – forum

Academics and practitioners at the latest Peregrine Perspectives debate have rejected the EU ban on naked CDS positions – which were brought in as a part-answer to the region’s sovereign debt crisis.

This rejection is based on assertions that there is no evidence the ban is helping either markets or investors.

Lara Cathcart, senior lecturer at Imperial College, said that trading activity alone has no meaningful impact on sovereign default risk, as it does not cause the cost of borrowing for countries to increase.

Panellist Paul Crean (pictured), co-founder and CIO of Finisterre Capital, an emerging markets fixed-income specialist, explained investors often use CDSs as liquid tools to hedge their underlying exposures against spread widening, not necessarily out of concerns for a possible default.

European politicians are understood to have pushed he ban based on the belief that a high volume of naked positions can increase the likelihood of default of troubled countries, by increasing their cost of borrowing.

However, Paul Crean said there is evidence the nominal volume of CDS positions alone is not big enough to have a meaningful impact on countries’ bond markets.

“CDS spreads are the symptoms, not the cause, of a country getting into trouble. Greece didn’t get into trouble because of CDS – it got into trouble because of its spending policy. Investors were desperate to hedge out their risk, and turned to CDS.”

Crean added that banning naked CDSs will cause liquidity deterioration for investors trying to hedge their exposures and, as a likely effect, force borrowers into shortening the maturity of their debt.

He also noted that fixed income markets have been a hiding place for investors for the past few years, but at some point interest rates will normalise and investors are going to need the ability to hedge.

“What is frightening is that the ban on naked CDSs is coming in at the very point that investors will need CDS protection more than ever,” he said.

 

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