The reaction to a ban on naked short selling introduced in Germany last month was probably not what the country’s regulator, the Bundesanstalt für Finanzdienstleistungsaufsicht (Bafin), or the German finance ministry had been expecting. The rules themselves, while initially vague, were narrow in scope and clearly meant for a domestic audience. Nonetheless, markets went into freefall, apparently spooked by a lack of co-ordination among European politicians. Equity markets across the globe sold off, the euro hit a four-year low against the dollar, and liquidity dried up in European corporate and government bond markets. As unintended consequences go, this one was a humdinger. There was, in fact, plenty of anxiety over the reach of the new rules on the morning of May 19. German dealers were unsure whether a ban on naked shorting of eurozone sovereign credit default swaps (CDSs) would extend beyond Germany, causing a number of firms, including Deutsche Bank, to halt trading in this instrument from London for a few hours. Participants were also uncertain whether the ban meant any German financial institution with exposure to small Greek or Spanish banks would not now be allowed to hedge using a sovereign CDS contract. Additional questions focused on bund auctions – would the decree mean dealers would be unable to pre-hedge? Would that affect the ability of governments to place debt? As it turned out, the loosest interpretation of the rules seems to have prevailed in each case. The reason, most now believe, is that the rules were politically motivated. Faced with a vote in Germany on the hugely unpopular €750 billion emergency loan package, chancellor Angela Merkel needed to be seen to be clamping down on the financial industry. In fact, one central banker suggests that in this context, far from acting unilaterally, the German decree can be viewed as the ultimate European gesture – a relatively benign set of rules, designed to see through a giant eurozone rescue package. The markets didn’t see it that way, hence the selling spree. Immediate fears appear to have subsided – but concerns persist over a possible debt restructuring by Greece, further contagion to Portugal and Spain, and the disintegration of the euro. Many, of course, feel the most likely scenario is Europe battling through the crisis, albeit with swingeing austerity measures. Some are not prepared to take the risk, however, particularly those outside Europe. Given that the problems faced by certain eurozone sovereigns have been flagged for months, no-one wants to stand up in front of their board and explain why they lost huge stacks of cash....
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