Sweden Says Short Selling Ban Will Cripple Small Debt Markets

EU Financial Services Commissioner Michel Barnier
The European Union's financial services commissioner Michel Barnier. Photographer: Jock Fistick/Bloomberg

Sweden is warning that European efforts to restrict short selling may cripple debt markets in smaller countries and says it will fight “shortsighted” proposals.

“If you ban naked short selling, that will mean more problems in funding countries’ national debts, especially for small countries,” said Bo Lundgren, 63, the head of Sweden’s National Debt Office, in an interview in Stockholm. “Hopefully, they will listen” to Swedish pleas to rethink a ban, he said.

The European Union is discussing measures to restrict short selling, a push the bloc “can’t afford to delay,” financial services chief Michel Barnier said on March 15. Germany and France are leading the drive to curb derivatives trading, a practice they say exacerbated Europe’s sovereign debt crisis. Leaders from the region’s smaller countries say stricter rules would undermine liquidity and jeopardize their debt sales.

“Too often -- I know as I was once a politician -- politicians are a bit shortsighted and don’t take analysis to heart,” said Lundgren, who in his former job as minister of fiscal and financial affairs helped rebuild Sweden’s bank industry after its 1990s meltdown.

In a short sale an investor borrows a security with a view to selling it and then repurchasing it at a lower price before returning it. In a naked short, an investor doesn’t need to borrow the underlying security.

Governments in the 27-nation EU and lawmakers in the European Parliament are discussing whether to restrict so-called naked short selling after German Chancellor Angela Merkel and French Finance Minister Christine Lagarde blamed the trade for encouraging speculation.

‘Panic Move’

Sweden says without the access to naked shorts -- which investors rely on to enter repurchase agreements with the country’s central bank -- bond-market liquidity will evaporate. The naked short contracts allow traders to generate more liquidity via the repo transaction than they’d be able to without access to the derivative, said Mats Hyden, chief strategist at Nordea Bank AB in Stockholm.

“The European Union’s plan to restrict naked short selling is a panic move,” Hyden said. “They’re chasing ghosts; the politicians are rushing and Sweden’s economy and its banks may be punished more than larger markets such as Germany or France. It all depends on how these rules are implemented.”

Sweden, which is backed by Luxembourg and Italy in opposing a ban on naked shorts, risks a surge in borrowing costs should a ban be approved, said Thomas Olofsson, head of debt management at Sweden’s national debt office, in an interview.

‘Increased Volatility’

“A loss of liquidity could mean increased volatility and interest rates,” Olofsson said. “Large investors like central banks, could in the worst case, be more cautious investing in smaller markets. This would be detrimental to smaller countries’ ability to handle situations in which they have to borrow larger amounts, such as during a crisis. The effect very much depends on how any new rule is applied. The devil is in the details.”

Lawmakers in the EU Parliament’s economic and monetary affairs committee in Strasbourg voted this month in favor of banning short selling of stocks or government bonds unless traders have “located and reserved,” in advance, the securities they intend to sell.

Barnier said final rules won’t harm liquidity and insists that sovereign debt “must be covered” by the EU proposals.

“Parliament wants to go much further,” Barnier said. “They voted for a complete ban on naked short selling of sovereign credit default swaps.” The EU Parliament is unlikely to agree to diluted rules, he said.

‘Add Uncertainty’

The Association for Financial Markets in Europe, which represents lenders including Deutsche Bank AG and UBS AG, has warned that “banning naked short selling is likely to raise the cost of borrowing for EU governments,” in a March 9 statement. “It will make financial markets less liquid and add uncertainty for European companies looking to hedge risk.”

Governments will try to complete work on short selling rules by May, said Gyorgy Matolcsy, the finance minister of Hungary, which holds the EU’s rotating presidency.

The EU will “work hard to finalize the text” for the next meeting of Europe’s finance ministers, he said.

Governments would need to reach a compromise with the European Parliament on the rules before they could become law.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE