May 19 (Bloomberg) -- Credit-default swaps soared as German Chancellor
Angela Merkel’s curb on using the contracts to speculate on European sovereign debt sparked concern among investors about increasing government regulation.
The
Markit iTraxx Crossover index of swaps on 50 European companies surged 50 basis points to 582, according to Markit Group Ltd., while the Markit iTraxx Asia index on investment- grade borrowers outside Japan climbed 10 basis points to 131.5, Royal Bank of Scotland Group Plc prices show.
The jump in the indexes signals a deterioration in investor perceptions of credit quality.
Merkel’s coalition stopped traders buying default protection on government bonds they don’t own, so-called naked swaps, as German lawmakers debate a bill authorizing their contribution to a $1 trillion bailout to support the euro. The unexpected ban, done independently of the European Union, came after the rescue package failed to stop the 16-nation common currency from weakening to a four-year low and as banks became increasingly reluctant to lend to one another.
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The market sees an inadequate policy such as this as an act of desperation and a refusal to address the fundamental problems at hand,” said
Brian Yelvington, head of fixed-income strategy at Knight Libertas LLC in Greenwich, Connecticut.
Prohibiting speculation in the contracts may cause trading in swaps tied to Europe government bonds to freeze up, said
Tim Backshall, the chief strategist at Credit Derivatives Research LLC in Walnut Creek, California.
Trading limits may increase borrowing costs or limit the flow of capital, he said.
Germany’s ban, which took effect at midnight Frankfurt time and lasts until March 31, 2011, also applies to the shares of 10 banks and insurers, German financial regulator BaFin said in an e-mailed statement.
The move failed to buoy the euro, which fell 0.5 percent to its lowest level in four years, before recovering to $1.2204 as of 7:48 a.m. in New York, from $1.2202 yesterday.
German Chancellor Merkel said today the prohibition on short-selling ban was part of an attempt to gain control over “destructive” financial markets. Stocks slid, with the
Stoxx 600 Europe index falling 2.4 percent.
The ban was needed because of “exceptional volatility” in euro-area bonds, BaFin said.
The ban doesn’t cover branches of German institutions outside of that country or in the U.K., according to Britain’s Financial Services Authority. The majority of credit-default swap trading takes place in New York and London.
The move may have little effect unless the U.S. does the same, according to
Hisayoshi Nogawa, a strategist at BNP Paribas Securities Japan Ltd. in Tokyo.
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It would be meaningless to regulate only in Europe if they are targeting hedge funds,” he said in a telephone interview today. Much “depends on how the U.S reacts to this.”
The announcement came the same day that a report showed German investor confidence plunged in May as Europe’s deepening debt crisis stoked concern about the euro’s future.
The ZEW Center for European Economic Research in Mannheim said its index of investor and analyst expectations dropped to 45.8 from 53 in April, the biggest decline since the collapse of Lehman Brothers Holdings Inc. in September 2008.
The Markit iTraxx Japan index jumped 14 basis points to 138 in Tokyo, according to Morgan Stanley. In New York, the Markit CDX North America Investment Grade Index Series 14 fell 1.8 basis points today to 118.9, Barclays Capital prices show.
Credit swaps tied to Greece’s government debt dropped 0.5 basis point to 613.5, while Portugal rose 4.5 basis points to 276, according to CMA DataVision prices. Contracts on Italy rose 3 basis points to 140, Ireland dropped 9 to 195 and Spain was 3 basis points lower at 178, CMA prices show.
Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt. The contracts are used to hedge against losses on corporate debt and bet on creditworthiness.
Bets made with swaps on the bonds of 10 European nations including Greece, Spain, Italy and Portugal total less than $108 billion, according to the
Depository Trust & Clearing Corp., which runs a central registry that captures most trading. That’s 0.97 percent of the $11 trillion in outstanding debt of those countries, International Monetary Fund data show.
BaFin itself said two months ago it found “no evidence” that credit-default swaps were being used excessively to speculate against Greek bonds. Depository Trust data “do not support the conclusion that speculation is taking place on a massive scale,” the regulator said in a March 8 statement on its Web site.
Concern that nations led by Greece will struggle to meet the EU’s requirements to lower their budget deficits has driven the euro to below $1.22 from last year’s high of $1.5144 in November.
Wolfgang Schaeuble said the government decided it was best to introduce the ban on naked short-selling as soon as possible. “If you do something like this, you don’t let it drag out but you implement it right away,” he said in an interview on ZDF television.
Merkel and French President
Nicolas Sarkozy have called for curbs on speculating with sovereign credit-default swaps. EU Financial Services Commissioner
Michel Barnier called this week for stricter disclosure requirements on the transactions. Last month, the EU proposed that the Financial Stability Board, set up by the Group of 20 nations to monitor financial trends, “closely examine the role” of swaps on sovereign bonds.
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In some ways, it’s a battle of the politicians against the markets” and “I’m determined to win,” Merkel said May 6. “The speculators are our adversaries.”
The move also added to concern the EU nations aren’t working in coordination.
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Since it’s not synchronized, it smacks of knee-jerk panic,” said Scott MacDonald, head of credit and economics research at Aladdin Capital Holdings LLC in Stamford, Connecticut, which oversees $12.5 billion. “This has a huge potential impact on credit-default swaps. You’re saying CDS is evil.”
