Germany bans short-selling to uphold financial stability

The move to ban the so-called naked short-selling of euro zone government debt and shares of major financial companies is being seen as an attempt by the regulator, BaFin, to strengthen the control of markets and maintain financial steadiness.

The root cause
BaFin cited the "extraordinary volatility" troubling eurozone countries' debt certificates as the reason for introduction of the ban. The ban also has roots in the widening of spreads on credit default swaps for several nations.

“Against this background, massive short-selling of the affected debt certificates and the conclusion of naked CDS on loan default risks of eurozone states would have as a consequence further excessive price movements," BaFin said in a statement.

Those could lead to "significant detriment for the financial market and could endanger the stability of the whole financial system," it added.

The said ban will come into force at midnight Tuesday and run through March 31, 2011. It would however be reviewed constantly.

Experts opine that such measures may boomerang and so unnerve, rather than calm, the already nervous markets.

Naked short-selling entails selling shares or investments by a trader who has no knowledge about them. On the other hand Credit default swaps are a kind of insurance against a borrower going insolvent.

The critics
While Germany claims short-selling trades are to be blamed for much of Europe debt crisis and therefore a ban is justified, the decision has its share of critics.

"Germany just switched off the financial lights in Europe," said a senior forex trader at a European bank in Singapore.

Experts opine that such measures may boomerang and so unnerve, rather than calm, the already nervous markets.

"Germany's announcement ... dented risk appetite as it raises the question as to whether the German regulator knows something the market doesn't. If there is a secret here, it can't possibly be a positive one,” Rabobank said in a note.

Investors, wary of regulatory concerns, will refrain from betting against European assets and would rather bet against the euro since there is no ban on short-selling there.

Marc Chandler, the chief foreign exchange strategist at a New York investment firm opined, "The German ban seems to be a bit of 'flailing,'" It appears to be half-baked and not really thought out, and plays into market doubts about European policymaking credibility."

It may be recalled that during the financial crisis in 2008, there was a ban on short-sales for close to three weeks. That ban proved counterproductive and did not help stabilize asset prices at all.