The naked CDS ban 6 months on April 21, 2013 at 2:35 pm
The FT has a timely article on the consequences of the EU’s ban on naked CDS:
Investors are buying protection on European banks on the basis that banks and sovereigns are so intimately linked that any increased risk of a sovereign default will increase the value of a bank CDS in a similar way to a sovereign CDS.
“The big downside of the ban is that it is likely to increase borrowing costs for financials,” said Michael Hampden-Turner, Citigroup credit strategist.
“It is hardly good for Spanish and Italian banks if the cost of borrowing is being squeezed up on the back of European regulation.”
Essentially then national champion banks are being used as proxies for the sovereign, with CDS buying (driven in part by CVA hedging) pushing out these banks’ credit spreads. The only way this loop will be broken will be if sovereigns either post collateral against their OTC derivatives (unlikely) or clear (somewhat more likely, but with its own problems).