EU, Merkel Urge Swap Regulation as Greece Takes Plea to U.S.

(Bloomberg) -- The European Union’s top regulatory official said the bloc will consider banning “purely speculative” credit-default swaps as German Chancellor Angela Merkel called for a crackdown on derivatives trading to prevent a rerun of the Greek financial crisis.

European Commission President Jose Barroso said today the 27-nation region will “examine closely the relevance of banning purely speculative naked sales on credit-default swaps.” Merkel, speaking before Greek Prime Minister George Papandreou meets President Barack Obama in Washington today, said the EU must take the lead in curbing derivatives.

“We’re of the opinion that a quick implementation of actions in the area of CDS has to happen,” Merkel told reporters in Luxembourg. Citing “ongoing speculation against euro-region countries,” she called for the “fastest possible” implementation of new rules.

European leaders are ratcheting up the pressure for global regulation of derivatives amid the Greek fiscal crisis. The commission, the EU’s executive arm, will also propose creating a lender of last resort to aid cash-strapped members such as Greece, a proposal that has divided the region’s leaders.

Papandreou said in a speech in Washington yesterday that “unprincipled speculators” threatened a new global financial crisis and said he’d press Obama to support EU efforts to target speculation.

‘Enough Is Enough’

“Europe and America must say ‘enough is enough’ to those speculators who only place value on immediate returns, with utter disregard for the consequences on the larger economic system,” Papandreou said.

Germany’s BaFin financial regulator said market data doesn’t back up claims that swaps were used to speculate against Greek bonds. Data provided by the U.S. Depository Trust & Clearing Corporation didn’t show that new open positions were built up and also didn’t indicate “massive speculative action,” BaFin said in a statement yesterday.

Blaming derivatives for Greece’s debt crisis “confuses cause and effect,” and a ban could lead to “mispricing of financial risks,” said Tim Brunne, a credit strategist at UniCredit SpA in Munich.

The cost of swaps on Greek bonds surged to a record on concern the government will struggle to repay more than 20 billion euros ($27 billion) of debt coming due by the end of May. The risk premium investors demand to buy Greek 10-year bonds over comparable German debt has also surged, causing a jump in the country’s borrowing costs. The spread is currently 305 basis points, more than twice the level at the start of November.

Lacking Transparency

“The CDS market has developed very strongly and drives prices in bond markets,” Bundesbank President Axel Weber, a European Central Bank governing-council member, told reporters today in Frankfurt. “Not everybody who buys protection has an underlying exposure. It’s a very intransparent market, we need to have a much more transparency.”

Papandreou compared investors buying protection on underlying assets they don’t own -- so-called naked swaps -- to someone taking out fire insurance on a neighbor’s house. They then have an incentive to burn it down to collect, he said.

U.K. Finanical Services Authority Chairman Adair Turner told a parliamentary committee last week that CDS, and naked CDS in particular, need to be examined by policy makers.

Speaking in a telephone interview before Barroso made his comments, FSA Spokesman Joseph Eyre referred to Turner’s testimony last week. The FSA didn’t return a call or e-mail seeking comment on Barroso’s speech.

‘No Useful Purpose’

“Naked CDS serve no useful purpose and are dangerous,” Richard Portes, professor of economics at London Business School, said in a telephone interview today. “They do not help significantly price discovery or liquidity. They’re not analogous to short selling equities because they will affect the cost of funding.”

Barroso said that he would press leaders of the Group of 20 nations to curb swaps at a meeting in June. He also said that the creation of a European Monetary Fund to aid struggling EU members would be a long-term proposal that may require changes to EU regulations. Yesterday, Merkel indicated that a proposal to create the lender of last resort could be ready by June.

Merkel, whose finance minister Wolfgang Schaeuble champions the idea of such a fund, said it would work as “a measure of last resort” and only after “a cascade of sanctions” against governments that break euro rules. Amending European treaties would be required, she said.

‘Other Ideas’

French Finance Minister Christine Lagarde said today an EMF may not be the best option. “Other ideas need to be studied and those that respect the Lisbon treaty are much preferable,” she said in Paris. The ECB’s Weber also questioned the fund proposal, saying that there should not be “institutionalizing of emergency aid.”

Greece’s ability to tame the EU’s largest budget gap, at 12.7 percent of gross domestic product, prompted speculation that the country would need a bailout and could be forced to abandoned the single currency. The euro has declined 5 percent this year as Greece’s financial woes undermined raised questions about the strength of monetary union.

Papandreou’s government last week outlined measures to save 4.8 billion euros ($6.5 billion), including higher fuel, tobacco and sales taxes, as it seeks to lop 4 percentage points off the budget deficit. It was the third package of measures this year and the government said it would guarantee that Greece would make good on a pledge to trim the shortfall to 8.7 percent in 2010.

Greece is “on track” to achieve its deficit-cutting goals following the passage of extra austerity measures, EU Economic and Monetary Affairs Commissioner Olli Rehn said today in an interview in Strasbourg, France. The new measures put Greece “onto the path of fiscal adjustment for 2012 below 3 percent” of GDP, he said.