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Naked Credit-Default Swap Traders Face Tougher European Rules

Naked credit-default swaps on corporate and sovereign debt may be restricted under measures proposed by a European Parliament member.

Sovereign credit-default swaps should only be used to insure bonds owned by the investor, Pascal Canfin, a French Green party member of parliament sponsoring the bill said in a report today. Canfin also said positions in corporate swaps should be disclosed to regulators.

The European Commission, the European Union’s executive arm, proposed rules in September to restrict so-called short selling by requiring traders to submit proof they can access the underlying shares or sovereign bonds to settle a trade designed to profit from falling prices. The rules would bring the EU closer to the stance taken by Germany, where Chancellor Angela Merkel banned some naked short selling in May.

Sovereign swap markets have “a major impact on the interest rates and therefore on the allocation of assets within the real economy,” Canfin said in his report. “The inefficiency of these markets can lead to distortions in the allocation of capital for the real economy.”

Credit-default swaps are derivatives that pay the buyer face value if a borrower -- a country or a company -- defaults. In exchange, the swap seller gets the underlying securities or the cash equivalent. Traders in naked credit-default swaps buy and sell insurance on bonds they don’t own.

The EU parliament will discuss Canfin’s report before agreeing on a final position. The proposals need approval from the 27 finance ministers of the EU bloc, the parliament and commission before they can become law.

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