Fri, Oct 9, 2015
Welcome Guest
Free Trial RSS
Get FREE trial access to our award winning publications
Industry Updates

EDHEC-Risk to the European Commission: prohibiting “naked” sales of sovereign CDSs would be inapplicable, even counterproductive

Monday, March 15, 2010
Opalesque Industry Update - In an open letter addressed to European Internal Market Commissioner Michel Barnier on March 15, 2010, EDHEC-Risk Institute has warned of the dangers of prohibiting “naked” sales of sovereign credit default swaps.

Besides the fact that the lack of convergence on these issues with the US authorities leaves little hope of the measures being effective, EDHEC-Risk Institute thinks that this ban would pose numerous problems and run up against legal and practical obstacles that would make it inapplicable or even counterproductive:

 It will be impossible for intermediaries and ultimately for regulators to verify investors’ holdings of the securities representative of the risk the credit default swaps are assumed to cover.

 A strict obligation to use credit default swaps to hedge the risk of sovereign debt would prevent sovereign nations from issuing long-term debt, as the CDS market for hedges of more than ten years is relatively illiquid.

 This prohibition would make it harder for countries to manage the interest rate risk on their debt actively, as their counterparties would then no longer be able to hedge the country risk of the interest rate swaps they may have entered into. This active management of the yield curve is a major component in the optimisation of the cost of public debt.

 More harmful still is that a very strict definition of a naked sale would keep investors who finance public investment or companies that enter into contracts with sovereign nations or with state-owned companies from hedging the default risk of their counterparties. At a time when public-private partnerships and private financing of public infrastructure projects are considered one of the drivers of global growth, making it harder to manage country risk may, at the very least, increase the costs of these partnerships and this financing and, at worst, prove a major hurdle to their development.

 Finally, by making the market for hedging default risk more complex, the markets may be deprived of the debt of countries with low ratings, of investors, and thus of liquidity, which will inevitably increase the cost of this debt.

It must not be forgotten that the primary reason for the plunging ratings of Greek debt—and the sharply rising cost—is that the Greek economy and the country’s public finances are in difficulty. By allowing Greece to deviate greatly from the budgetary rules imposed on the eurozone, the leaders of the eurozone have demonstrated blameworthy indulgence. By failing, even in a period of relative growth, to abide by the rules for euro eligibility, the leaders France and Germany, to be sure, set a very bad example for the small and profligate countries of the eurozone. It is always hard to convince others to do as one says and not as one does.

It is easy to understand now why Christine Lagarde, who often had to explain to Brussels that the recovery plans for French public finances would not, in contempt of treaties and commitments, be adhered to, would rather dwell on the role speculators have played in the Greek tragedy and in the troubles plaguing the euro than on that played by European leaders. It is not as if we will not see the forest of a European Commission unable to impose budgetary discipline on nations for all the trees of Greek credit default swaps, which, after all, come to a net nominal amount that does not exceed 5% of the Greek public debt.

Ultimately, sound regulation of the CDS market depends not on prohibitions but on transparency and on centralised clearing. In this respect, the lag in Europe must be emphasised. For the moment, American market infrastructure dominates the business for the recording and clearing of credit derivatives. Instead of slapping the invisible hand of speculators, it would be more effective for preeminent European countries to agree on a common infrastructure for the euro credit derivatives market.

About EDHEC-Risk Institute
The aim of the EDHEC-Risk Institute is to produce research that meets the most stringent academic standards and to facilitate corporate use of this research. In partnership with large financial institutions, the EDHEC-Risk Institute brings together 47 researchers and implements six industry-sponsored programmes and ten research chairs focusing on asset allocation and risk management in the traditional and alternative investment universes.


What do you think?

   Use "anonymous" as my name    |   Alert me via email on new comments   |   
Today's Exclusives Today's Other Voices More Exclusives
Previous Opalesque Exclusives                                  
More Other Voices
Previous Other Voices                                               
Access Alternative Market Briefing

  • Top Forwarded
  • Top Tracked
  • Top Searched
  1. Investing - AQR Capital and Renaissance Technologies raise stakes in Southwest Airlines[more]

    From In the previous part of this series, we saw how institutional investors played Southwest Airlines (LUV) in 2Q15. Now let’s move on to the trades executed by key hedge funds in Southwest Airlines over the same period. … Most of the hedge funds that had significant exposu

  2. Manager Profile - Pimco alternative funds flourish as 30-year bond rally fades[more]

    From Inside Pacific Investment Management Co., the bond behemoth that lost two chief investment officers last year and saw almost $500 billion of client money leave, a hidden profit engine is easing some of the pain. For more than a decade, Newport Beach, California-based Pimco has qu

  3. Niche Investing - Art investment funds: Attracting institutional and other new investors[more]

    From The Deloitte/ArtTactic Art and Finance Report 2014 (the "Art and Finance Report") noted that the "global art investment fund market was estimated to be worth at least $1.26 billion in the first half of 2014." This seems almost inconsequential when juxtaposed with the $54 billion of

  4. Hedge fund Barnegat survives September’s market selloff[more]

    Komfie Manalo, Opalesque Asia: Bob Treue’s $679 million Barnegat Fund proved resilient after another month of market letdown as the hedge fund gained 2.2% last month, bringing its year-to-date gains to 2.8%. Treue said in his monthly report to i

  5. …And Finally - Japanese men want upgrade on their virtual girlfriends[more]

    From Five years after News of the Weird mentioned it, Japan's Love Plus virtual-girlfriend app is more popular than ever, serving a growing segment of the country's lonely males -- those beyond peak marital years and resigned to artificial "relationships." Love Plus models (Rinko