(This story previously appeared on IFRe.com, a Thomson Reuters
By Christopher Whittall
LONDON, Oct 31 (IFR) - Soaring volumes in European
government bond futures have exposed a flaw in EU regulation
designed to halt speculators from driving up funding costs in
the periphery by shorting government debt.
A ban on "naked" short positions in European sovereign
credit default swaps is set to come into force tomorrow, causing
many participants to steer away from the sovereign CDS market to
hedge or take views on the eurozone.
But far from being prevented from shorting vulnerable
sovereigns, investors have found a simple way to skirt around
the rules by shifting positions into exchange-traded government
bond futures that are not subject to the new regulation.
Open interest in Eurex-listed Italian BTP futures has almost
doubled since the announcement of the ban back in March, from
32,271 to a new peak of 62,489.
Volumes in OAT futures have rocketed even more sharply with
open interest reaching a high of 146,923 on October 24 despite
the contracts only launching in April.
"The growth in futures volumes is unbelievable," said one
senior credit trader. "The same short interest still exists -
economically it's identical. If you thought the short interest
was hurting the market then it makes no sense to say cleared
derivatives are good and OTC derivatives are bad."
Dealers have expressed concern that the EU ban could
severely damage the sovereign CDS market, which is viewed by
many as supportive of government bond markets. Volumes have
already tumbled, with the net notional in EU CDS dropping from a
peak of just under USD140bn net notional outstanding in mid-2011
to around USD112bn currently.
Experts say the effects are becoming particularly notable in
central and eastern Europe sovereign CDS, where the cash-CDS
basis has already tightened considerably.
Meanwhile, analysts at Morgan Stanley calculated there had
been USD286bn of net new trading in western European sovereign
CDS since the ban was announced, estimating that further
position unwinds would be necessary to comply with the rules.
The ban has also caused a shake-up in the index market, with
Markit's iTraxx SovX Western Europe index likely to get scrapped
as a result of not complying with the new regulations, and its
CEEMEA index omitting EU names in order to survive.
Bankers have expressed bemusement at the clear
inconsistencies in the new rules, with regulators allowing
futures while shunning CDS shorting, although some reckon it is
yet another sign of regulators favouring exchange-traded markets
over OTC business.
"Futures are cleared, and people like that. It will also
stop the "big bad" OTC guys doing their stuff," said the senior
(Reporting by Christopher Whittall, Editing by Helen