| NEW YORK, April 11
NEW YORK, April 11 The International Monetary
fund said the European Union was
moving in the wrong direction by banning the use of a hedging
strategy related to sovereign credit default swaps.
In a report published on Thursday ahead of its annual
meeting April 19-21, the IMF said the ban on so-called naked
SCDS is not supported by any empirical evidence and could in
fact lead to more instability in the financial markets.
Credit default swaps act as a kind of insurance for
investors who own debt, in this case debt issued by sovereign
nations, against potential default or restructuring.
"Overall, the evidence here does not support the need to ban
purchases of naked SCDS protection," the IMF said, adding that
negative perceptions about the instruments are not backed up by
An EU rule came into effect Nov. 1 that banned speculative
trading in the contracts. A naked contract means the investor
does not have an offsetting position in the underlying asset
even though they own protection against a rise or fall in the
price of the asset.
At the height of the financial crisis, CDS came in for major
criticism and were seen as one potential destabilizing factor in
the market. The IMF says this is difficult to assess since risks
affecting SCDS are the same as those affecting other areas of
the financial system.
According to the IMF study, the SCDS market had a net
notional value of $3 trillion at the end of June last year,
compared with $50 trillion for total government debt outstanding
at the end of 2011.
In the CDS market, net notional positions generally
represent the maximum possible amount of money that will change
hands between those who sold and those who bought credit
protection in the event of a default or restructuring.
"The recent European ban on purchasing naked SCDS protection
appears to move in the wrong direction. While the effects of the
ban are hard to distinguish from the influence of other policy
announcements, the prohibition may have already caused some
impairment of market liquidity," the IMF said.
The IMF study found the SCDS market and the sovereign debt
market are both equally influenced by financial market risk
However, if there is a liquid SCDS market, it will react
faster and incorporate information quicker during times of
financial market stress relative to the bond markets.
"Overall, SCDS markets do not appear to be particularly more
prone to high volatility than other financial markets," the IMF
Nor do the price movements in the SCDS market appear to lead
to increased costs for sovereigns selling debt in the markets.
The IMF said it was encouraged that the European Securities
and Markets Authority will present an investigation to the
European Parliament by June 30 on the effects of the regulation.
"In general, the benefits of bans on short positions - to
stabilize financial markets, support prices, or contain credit
spreads - have not been empirically verified in studies of other
bans," the report said.
"Bans on short selling in equity markets are generally
viewed as merely reducing market liquidity, hindering price
discovery, and increasing price volatility."