In May this year we reported that a draft Regulation on short selling and credit default swaps (Short selling regulation?) is being prepared by the European institutions. Last week an agreement has been reached between the Council and the Parliament on this matter and only a formal endorsement lacks before this Regulation enters into force. The new rules are supposed to increase transparency, responsibility and stability in short selling transactions that are so often difficult to understand by consumers. After the regulation is enacted the short positions will need to be disclosed to regulators and they will have the power to limit short selling on a temporary basis in exceptional situations. This regulation is one of the measures that is seen as necessary to restore a healthy financial market and prevent future financial crisis (since short selling was seen as an aggravating factor in price declines in distressed markets).
"In a welcome improvement to our original proposal, so-called "naked" sovereign CDS positions will be prohibited where sovereign CDS are not acquired to hedge an exposure which is correlated to the value of the sovereign debt. The restriction will not apply to primary dealers and market makers. A competent authority will be able to temporarily suspend these restrictions where it believes, based on objective elements, that its sovereign debt market is not functioning properly and that such restrictions might have a negative impact on the sovereign credit default swap market. These balanced measures will ensure that sovereign CDS are used for the purpose for which they were designed, hedging against the risk of sovereign default, without putting at risk the proper functioning of sovereign debt markets." (Commissioner Michel Barnier welcomes trilogue agreement by Council and Parliament on new rules for short selling and Credit Default Swaps).
See FAQ for more details on this new regulation.