The European Commission sees eye to eye with the leaders of France, Germany, Luxembourg and Greece, who are eager to curtail the trade in sovereign credit default swaps (CDS). The four wrote to the EU executive on 10 March demanding it begin an investigation into the speculative use of CDS, which Greek premier George Papandreou says are partly to blame for the inflated interest rates he is now forced to pay to issue Greek government bonds. Speaking on 12 March, a spokesman for the EU executive said it “welcomes” the letter sent by the four leaders and will conduct an inquiry “as quickly as possible” into whether it can ban speculative trading.

Sovereign swaps are credit derivatives where one party to a contract gets paid if the country that issued the underlying bonds goes bust. They have been likened to insurance contracts because the investor is effectively buying cover for the underlying bonds, and are legitimately used by investors to hedge risk. What the Commission is concerned about is when the contract is drawn up without owning the underlying bonds – “naked” selling. It is this practice that Commission President José Manuel Barroso talked about banning during a speech to the European Parliament on 9 March.

In the letter, seen by Europolitics, the four leaders write: “We must prevent speculative actions from causing so much uncertainty on the market that prices no longer provide accurate information and state financing reaches a fundamentally unjustifiable high level.” It is signed by France’s President Nicolas Sarkozy, Luxembourg’s Prime Minister Jean-Claude Juncker, Germany’s Chancellor Angela Merkel and Greece’s Prime Minster Georgios Papandreou.

They refer to the punitive interest rates being paid by Greece on a 5 March bond issue, which topped 6%, twice the rate Germany pays for its benchmark bonds (considered a benchmark). They want the Commission to consider “minimum holding periods for CDS trading, banning speculative CDS trading as well as banning the acquisition of CDS which are not being used for hedging purposes”.

The market in CDS was worth over US$36 trillion by June last year, according to the Bank for International Settlements, and around US$1 trillion of that was sovereign CDS. Figures compiled by clearing house DTCC say that CDS make up only around 8% of Greek government bond transactions, while Barclays says CDS exposure as a percentage of Greek debt is only around 4%.

The four leaders are asking the Commission to present the results of their enquiries at future EcoFin meetings. Finance ministers will meet again in Brussels on 15 and 16 March (see separate article) for their regular monthly talks, which will focus on the Greek stability and convergence programme and a draft agreement on hedge funds.

Text of the letter on www.europolitics.info > Search = 268259