The UK proposes to scrap EU restrictions against short-selling sovereign bonds. It argues that allowing hedge funds and other investors to bet on government bonds would increase liquidity in the PS2.4tn market for gilts.
The Treasury announced on Tuesday that it wants to lift a ban on short-selling gilts which was inherited from EU. This ban prevents investors entering into a short position without borrowing the bonds. The Treasury also plans to remove the requirement for investors to report large short positions in gilts. It will also lift the ban on the purchase of naked credit default swaps, which are contracts similar to insurance that pay out when the UK government defaults on its debt.
Treasury stated in a consultation with the industry launched on Tuesday that “short selling sovereign debt and holding sovereign CDS contribute to a healthy functioning of sovereign bond markets by promoting liquidity and helping price discovery.”
The UK raised concerns about the restrictions when they first were proposed in 2010, because they could negatively impact the liquidity of gilts.
The EU short-selling curbs were implemented in 2012 during a time when European politicians blamed hedge funds that were involved in short selling for raising sovereign borrowing costs in distressed economies like Greece and resulting in bailouts. The UK, which is the main CDS trading hub for the EU, was the only state to not vote in favor of the measures.
The “Edinburgh Reforms” are part of an effort after Brexit to undo a number of regulations that were inherited from EU to increase the competitiveness of UK Capital Markets. Jeremy Hunt, the chancellor of the UK, announced plans to eliminate “almost 100 unnecessary pieces of retained EU law” in his Mansion House address on Monday.
In December, the UK also began a review on short-selling regulations at stock exchanges.
The Treasury stated that the EU’s curbs on sovereign debt have not had the desired effect, citing an IMF Report from 2013 that found that there was “little evidence” that purchasing CDS increased the cost of borrowing for sovereigns.
The report added that, while “covering requirements”, which prevent investors selling short positions on securities they don’t own, are important in equity markets, where the total number of shares is relatively low, sovereign debt markets, with their much greater volume, do not present the same liquidity risk.
Jack Inglis is the chief executive of hedge-fund lobby group Alternative Investment Management Association. He said: “It is great to see that the UK government is considering a fundamental overhaul of UK short selling regulations, with a commitment to eliminate harmful transparency about individual firms’ positions in short sales, as well as moving to rip up the rules on sovereign debt and CDS.”