Banks Defend Sovereign Default Swaps at EU Regulators’ Meeting

March 6 (Bloomberg) -- The banking industry argued at a meeting with European Union regulators that trading in sovereign credit-default swaps isn’t large enough to affect Greek bond prices.

Swaps account for “only a small percentage of government bond trading volumes,” so it isn’t likely speculation in the contracts is “dictating price levels in the larger government bond market,” the International Swaps & Derivatives Association, an industry group, said in a statement yesterday. The group said the Brussels meeting offered a chance to address “misconceptions” about credit swaps.

Banks and regulators across Europe were summoned by the European Commission to an informal meeting to discuss regulation of the market for sovereign credit-default swaps in the wake of the Greek debt crisis. European leaders have said the products fuel speculation that can distort market perceptions, making it harder for countries to borrow.

The commission, the EU executive agency, should ban naked swaps speculation, where investors insure bonds they don’t own, because “it is a demonstrably dangerous market,” Richard Portes, founder of the Centre for Economic Policy Research, said in a telephone interview. “If I were the commission, I’d ask the banks to say what social function the trade in naked CDS has.”

The roundtable yesterday was a “technical meeting,” and the discussions will be taken into account for the commission’s planned derivatives proposals later this year, Chantal Hughes, a commission spokeswoman, told reporters in Brussels.

Face Value for Debt

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a country or company default on its debt payments.

“The absence of competition between banks also means that the possibilities of effective cartel behavior in the CDS market have increased,” Portes said.

ISDA defended sovereign swaps, saying in its statement they “can be used to hedge financial, industrial and real estate investments in countries.” The products allow investors to buy and sell default protection “without having access to government bond markets,” the group said.

German Chancellor Angela Merkel’s government is considering ways to tighten rules in the sovereign default swaps market. French Finance Minister Christine Lagarde said Feb. 17 “we should examine the suitability” of credit-default swaps.

The cost of such contracts on Greece rose to a record 428 basis points last month, according to CMA DataVision in London. That meant it cost $428,000 a year to insure $10 million of debt for five years.

Efforts to limit sovereign swaps contracts were criticized by Citigroup Inc. analysts in a note March 2. The analysts said governments should address investor concerns about budget deficits, rather than ban derivatives that hedge against risks.

“We would do better to spend our time addressing the defects the mirror shows than blaming the mirror,” Citigroup analysts, led by Michael Hampden-Turner in London, wrote in a note to investors. “After all, banning mirrors does nothing at all to make the world a prettier place.”