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).

3 Responses to “The naked CDS ban 6 months on”

  1. If you look closely at senior unsecured spreads for bank paper, it bears little resemblence to cds premia. And using cds premia as a proxy for bank cost of funds can be misleading because the overall cost of funds needs to capture the complete stock of liabilities. Sorry for whinge it just annoys me when cds are presented as the driver of bank funding costs. One of many drivers.

    Incidentally, look at the 10k reports of UK banks and you’ll see some surprising rankings of cost of funds

  2. […] banned buying naked CDS on Euro sovereigns so people just buy them on Euro banks instead. Close enough. And of course, that puts everyone into ‘partial’ hedges rather than the […]

  3. Fair enough QM – I absolutely agree that bank CDS spreads are becoming increasingly unconnected with bank borrowing costs.