Market puzzled by Bafin ban

Some trading desks were closed for business this morning while the market waited for clarity on a ban announced overnight by the German securities regulator Bundesanstalt für Finanzdienstleistungsaufsicht (Bafin). The 889-word decree left many questions unanswered, but prohibits the naked short selling of eurozone government bonds, credit default swaps (CDSs) on those bonds and 10 German financial stocks. Some banks reacted by calling a halt to anything that might fall foul of the new rules.

"This morning, there were a few firms that decided not to trade sovereign CDSs any more. There were some who decided not to sell bunds to their clients," says the global head of debt and credit trading at one large European bank. "They will certainly reverse that decision soon, but the first consequence of the announcement has been complete illiquidity - if you don't know what you can use as a hedge, you stop trading."

Bafin has yet to flesh out the bans, but has promised to publish more answers today. It is unclear how the prohibitions - which are only effective in Germany - will work in practice and whether market makers will be exempt.

"It appears there has been no prior discussion with the market, so everyone is scrambling around trying to understand what the implications are. If it applies to market makers, then you can't offer somebody a bond unless you have inventory in that position, which means government bond trading has to shut down. The implications are just not clear," says one senior rates trader at a UK bank.

Markets endured a chaotic morning. As of 12.10 BST, euro-bund futures had risen to 127.32 from 126.86 at yesterday's close, the euro had dropped from $1.2335 to $1.2209 against the US dollar, and the Dow Jones Eurostoxx 50 index had tanked 3.04% to 2,616.26. Moves in sovereign CDSs were tempered, with five-year protection on Germany tightening from 44.4 basis points to 41.5bp and the Markit iTraxx SovX Western Europe narrowing from 123.1bp to 118.4bp, according to CMA DataVision. Of the financial stocks under naked shorting banks, CDSs on Deutsche Bank moved out around 7bp to 154.5bp and credit spreads on Commerzbank widened to 129.7bp from 124.4bp.

Most market participants Risk spoke to saw Bafin's announcement as politically motivated - the German chancellor Angela Merkel followed the ban with a barnstorming defence of the euro and an attack on banks - and some feared it would prompt similar bans from other countries. However, French economy minister Christine Lagarde rebuked Germany on Wednesday and said France was not planning to follow Germany's lead.

"It seems to me that one ought to at least seek the advice of the other member states concerned by this measure. Therefore, we are not considering doing it ... we are not considering following those measures," said Lagarde, Reuters reported.

The UK Financial Services Authority (FSA) has said the Bafin ban does not extend to German banks' operations in the UK. "We note what Germany has implemented and will assist Bafin wherever appropriate. The scope of these bans relates to German participants or business taking place inside Germany and does not cover branches of German institutions outside of Germany," says an FSA spokesman.

Meanwhile, as markets await further clarification from Bafin on the rules, traders and analysts continue to get to grips with the impact the bans could have on credit markets.

Tim Backshall, chief strategist at Credit Derivatives Research, wrote in a note on May 18: "Our guess at how much of the CDS market is naked is 70-80%. How does a ban on naked CDSs make any sense? So you can't buy protection unless you are long the bonds - does that mean the person selling you protection has to be short the bonds? And if they are short the bonds, are they naked short the bonds?"

This article first appeared on Risk.net