UK seeks to overturn EU ban on ‘naked’ short selling in gilt market

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The UK is proposing to scrap EU restrictions on short selling of sovereign bonds introduced during the eurozone debt crisis, arguing that making it easier for investors such as hedge funds to bet against government bonds will boost liquidity in the £2.4tn gilt market.

The Treasury said on Tuesday it wanted to end a ban inherited from the EU on “naked” short selling of gilts, which prevents investors from entering a short position unless they have borrowed the underlying bonds. It also planned to end a requirement to disclose sizeable short positions in gilts to the regulator and to overturn a ban on naked purchases of credit default swaps — insurance-like contracts that would pay out if the UK government defaulted on its debt.

“Short selling of sovereign debt and owning sovereign CDS generally contribute to the healthy functioning of sovereign debt markets, promoting liquidity and facilitating price discovery,” the Treasury said in an industry consultation launched on Tuesday.

It added that the current restrictions were “an unnecessary part of the regulatory regime”, noting that the UK had raised concerns when they were first proposed in 2010 because they could have a “detrimental impact on liquidity” in gilts.

The EU short selling curbs, which were made permanent in 2012, were introduced during a period when some European politicians blamed short selling hedge funds for driving up sovereign borrowing costs of distressed economies such as Greece, resulting in eventual bailouts. The UK, the bloc’s main CDS trading hub, was the only member state not to vote in favour of the measures.

The move to relax the curbs is part of a broader post-Brexit effort to unpick a slew of regulation inherited from the EU in a bid to boost the competitiveness of UK capital markets, dubbed the “Edinburgh reforms”. In his Mansion House speech on Monday, chancellor Jeremy Hunt outlined plans to scrap “almost 100 pieces of unnecessary retained EU law”.

The UK in December also launched a review of short selling regulations in stock markets.

The Treasury said the EU curbs on government debt had not had the desired impact, citing a 2013 IMF report that found “little indication” that buying CDS raised sovereign borrowing costs.

It added that while “covering” requirements, which prevent investors from selling short positions of securities that they do not own, are important for equity markets where the total amount of shares is relatively small, sovereign debt markets are much larger and do not have the same liquidity risks.

Jack Inglis, chief executive of hedge fund lobby group the Alternative Investment Management Association, said: “It’s great to see the UK government contemplating a fundamental shake-up of the UK’s short selling rules with the commitment to do away with harmful public transparency of individual firms’ short positions, while also moving to tear up the rules for sovereign debt and CDS.”