Three years after the outbreak of the financial crisis, the European Union seems determined to act on the market regulation front. In November 2012, if no further obstacles arise along the way, the reform that regulates the short selling and buying and selling of credit default swaps, i.e. those securities that act as insurance against the failure of bonds, including CDS, will enter into force. on government bonds.
Short selling – less aggressive strategies
As a disincentive to aggressive strategies, it will become necessary to notify the market if the sales involve more than 0,5% of the company's equity. If the transaction threshold is lower (0,2% of the principal), the notification need only be made to the supervisory authority. A further distinction will concern short selling of shares and sovereign debt bonds. For equities, shortselling is only permitted if the investor has borrowed the security, has an agreement to borrow it or has an agreement with a third party which has confirmed that the stock has been “located”. The same rules apply to bonds on government bonds. However, if the short transactions were to cover a long position in bonds of an issuer whose price has a high correlation with the price of sovereign debt.
Credit default swaps – “naked” swaps on sovereign debt are prohibited
Investors will have to notify the supervisory authority of CDS transactions relating to sovereign bonds only for significant positions. The same notification requirement applies when credit default swaps are used to obtain a "short" position on stocks or bonds. On the other hand, "uncovered" or "naked" CDSs on sovereign debt will be categorically prohibited, i.e. when the seller has not borrowed the securities and has no guarantee to be able to do so in the future. Should the liquidity of sovereign debt fall below a predetermined threshold, the authorities can suspend the restriction temporarily: from an initial period of 12 months, to further renewable periods of no longer than six months each. The suspension could, theoretically, be repeated indefinitely, but five conditions must be met: high interest rates on sovereign debt, an increase in spreads on sovereign debt and on sovereign CDS, times for the sovereign debt price to return to original balance after an intense trading phase, the amount of sovereign debt that can be transacted.
Market stability - if at risk, regulators can impose temporary transparency measures
A new clause will be introduced: "in case of risk of market stability", the supervisory authorities will be able to impose temporary measures of transparency and restrictions on the trading of securities and derivatives. Any blocking of transactions cannot last more than three months, but can be extended for a longer period, if suitably justified. The ESMA, the market guarantor authority in Europe, will have to verify that the same instrument is suspended from transactions in other countries.
The exceptions that prove the rule
Market making activities, operations on primary markets and shares whose main markets are located outside the European Union will be exempt from the new rules.
