Germany Bans Naked Short Selling

New rule affects country’s 10 most important financial institutions;
analysts skeptical move will help to calm markets

By Holger Hansen and Andreas Rinke
Reuters News Service
May 19, 2010

Germany, in an attack on the financial speculation on which it blames much of the euro zone’s debt crisis, on Tuesday announced a ban on some high-risk bets that prices of bonds and stocks will fall. 

Analysts, however, were skeptical that Germany’s surprise move to ban some trades in a strategy known as naked short selling could be effective in taming market volatility, with one saying it suggested “desperation.”

Germany’s lack of co-ordination with any other countries, including any other euro zone members, underscored the measure’s weakness as a tool to calm markets, analysts said. 

Naked short sales of euro-denominated government bonds, credit default swaps based on those bonds, and shares in Germany’s 10 leading financial institutions will be prohibited, a Finance Ministry spokesman said.

Credit default swaps, a type of derivative known as CDS, insure against the risk of debt defaults. 

“The ban takes effect at midnight,” a Finance Ministry spokesman said, confirming what sources in Germany’s ruling coalition had told Reuters earlier. A coalition source said Chancellor Angela Merkel would formally announce the ban on Wednesday. 

In naked short selling, a trader sells a financial instrument short, betting that its price will fall, without first borrowing the instrument or ensuring that it can be borrowed, as would be done in a conventional short sale.

The ban will run through March 31, 2011, according to the government’s financial watchdog, Bafin. 

Bafin said the move was “due to the extraordinary volatility in government bonds in the euro zone.” Massive short-selling could have endangered the stability of the financial system, it said. 

Analysts, however, were not convinced the ban would be effective, and traders said it increased uncertainty in the financial markets. 

“It tends to suggest desperation on the part of the German officials who want to discourage what they consider speculative attacks on euro zone financial markets,” said Michael Malpede, a senior analyst at Easy Forex in Chicago. 

Win Thin, senior currency strategist at Brown Brothers Harriman in New York, said such a ban could be futile.

“A big question is whether other countries follow suit,” he said. “Of course, the other euro zone members would most likely go along with Germany on this. 

“But given that this most recent leg of the crisis is centred on the peripheral euro zone, we can’t see why the U.S. or the U.K. would get involved. And given the global nature of the financial world, couldn’t a German investor simply use a U.S. counterparty to get around this ban? The report raises more questions than it answers.” 

There was no immediate sign that other European nations would imitate Germany. A spokesman for France’s Ministry of Economy said a short-selling ban introduced in 2008 for shares of French financial institutions was still in place; it did not comment on its intentions for the bond and CDS markets. 

It was also not clear how Germany could enforce the ban effectively in the debt and CDS markets, which stretch across national borders. Most European trade in CDS takes place in London. 

The euro fell back near a four-year low against the dollar and investors shifted money to safe-haven assets such as U.S. Treasuries after the news on the ban. Since the beginning of the year, the euro has lost about 14 per cent against the dollar. 

Bafin said the 10 financial institutions whose shares are covered by the ban are: Allianz, Commerzbank , Deutsche Bank, Muenchener Rueck, Deutsche Boerse, Deutsche Postbank , Hannover Rueck, Aareal Bank, Generali Deutschland and MLP. 

In response to the global financial crisis and the euro zone’s debt problems, the German government has been working on a bill to increase protection for investors and reduce wild swings in capital markets. 

Under plans sketched out earlier this year, naked short-selling would be forbidden by law as threatening the stability of financial markets. An electronic system for reporting and publishing short sale positions would be set up, with sanctions to ensure compliance. 

Ruling coalition sources said Finance Minister Wolfgang Schaeuble was now enacting the ban through an executive order. 

U.S. regulators are working on their own rules to curb stock trading when markets plunge uncontrollably, as happened on May 6 when the Dow Jones industrial average dropped some 700 points within minutes. 

The plan was hastily crafted by the Securities and Exchange Commission and major U.S. exchanges and will be implemented as soon as mid-June, source familiar with the plan told Reuters. 

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