There is increased speculation against euro over concerns of euro zone sovereign debt levels triggered by the Greek debt refinancing crisis.  The euro has already hit a four year low of $1.2209.  As expected and predicted in one of my earlier blogs, this crisis is forcing the shift much more aggressively towards water tight regulation mode from light touch supervision mode to ensure market stability, transparency and systemic risk management.

 This week the German Federal Financial Supervisory Authority (BaFin) temporarily prohibited naked short sales of euro debt securities, naked short selling of shares in 10 leading German financial institutions, and naked transactions of credit default swaps (CDS) linked to euro government debt. The bans apply from May 18 2200 GMT to March 31 2011, 2200 GMT. This does not impact transactions in the specified shares that are backed by securities lending.

The 10 firms being:

Aareal Bank AG

Allianz SE

Commerzbank AG

Deutsche Bank AG

Deutsche Boerse AG

Deutsche Postbank AG

Generali Deutschland Holding AG

Hannover Rueckversicherung AG

MLP AG

Muenchener Rueckversicherungs-Gesellschaft AG

 Earlier in March, BaFin also issued mandated that market participants notify it of any net short-selling positions in the same financial stocks of a threshold of 0.2 % or more and publish the same of a threshold of 0.5 % or more. This allowed BaFin to intervene sufficiently in advance and swiftly, against short-selling transactions that may trigger systemic risks. The provision provides for a two-tier transparency system: first, net short-selling positions of 0.2 % or more of the shares in issue of the specified companies must be notified to BaFin. Further notifications are required when such positions reach, exceed or fall below a further 0.1 % in each case. In addition, a publication of the position in anonymous form on the homepage of BaFin for 0.5 % or more.

This decree, aligns to the proposals published on 2 March 2010 by the Committee of European Securities Regulators (CESR), that include Bafin, for a pan-European transparency system for net short-selling positions. Paris-based CESR’s role is to coordinate national market regulators and make policy recommendations to the EU on securities regulation.

 I was expecting other EU block nations to synchronize or follow suit for a wider impact, but has not happened yet. But there are similar discussions or measures in place in selected EU countries. Austria’s finance ministry is calling for talks on long- term regulation of credit-default swaps and naked short-selling of sovereign debt. Portugal restricts naked short-selling as far back as 2008 onwards. France and Austria restrict short selling of financial shares from 2008 onwards. Germany, along with the U.S. and other EU nations, has also banned short selling of banks and insurance company shares in 2008. BaFin had lifted its ban in January and reinstated it back now.

Certainly many more regulatory changes are coming (today’s USA reforms proposal) but for this particular regulatory effort, my key takeaways are:

  1. Underscores the challenge the ambitious new EU Systemic Risk council will have in executing its charter and blueprint to manage systemic risk across EU.
  2.  Perhaps there is a regulatory arbitrage opportunity given that the ban applies to deals executed on German market? Maybe not, but we shall see.
  3.  Surveillance Technology - I will be talking to my middle office/market risk contacts to see how the front office trading control rooms/compliance process works to handle the naked short sell ban for specific instruments. Beyond manual instructions to Money Market, Equities, and Structured Products desks & traders, would firms look at front office trading systems technology to enforce automated alerts against trades? Would they use pre-deal positions limits? Would an automated rule trigger a BaFin reporting flag alert if positions breach the prescribed bands?
  4.  Increased pressure on governments to pass regulations against speculative practices
  5.  Traders with fat fingers being asked to tend gardens and stay away from trading floors (just kidding but an entirely plausible solution !)

 Research source: Bafin, Reuters, Dow Jones, Bloomberg