German Finance Minister Wolfgang Schaeuble defended the timing of the BaFin's ban in a TV interview earlier today: “If you do something like this, you don’t let it drag out but you implement it right away."
Although total CDS trades on the bonds of the 10 Eurozone countries are estimated to account for only $108 billion, less than 1% of the countries' $11 trillion in outstanding sovereign debt, the move threatens to close CDS markets and leaves investors jittery on threat of further regulation. The Austrian finance minister recently voiced his approval for a Europe-wide ban.
CDS are derivative contracts which function as insurance on the underlying asset. CDS spreads, i.e. the prices necessary to maintain a CDS contract, increase as investors lose confidence in the underlying asset. When the person selling a CDS contract or shorting a bank stock does not own the underlying asset, it is called a "naked" trade. In the case of government bonds, these are bets on a sovereign's ability to repay its public debt, with the spread increasing as investors lose confidence in the target sovereign. BaFin's regulation was meant to stop traders from betting against Eurozone countries' ability to repay their debt.
Analysts at US-based Credit Derivates Research LLC note that the removal of the possibility to hedge government bond risk may lead to broad-based repricing of all government bond risk, reversing on the regulation's intended ramifications.
Labels: Kajal Agrawal