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Trichet calls CDS regulation top priority

European Central Bank president Jean Claude Trichet, left, and IMF Managing Director Dominique Strauss-Kahn at a meeting in Brussels on Friday.

Virginia Mayo

Credit default swap markets need to be better regulated, and introducing a central clearing system for them is a top priority, European Central Bank president Jean-Claude Trichet said on Friday.

Mr. Trichet said CDS, which offer protection against debt default, should not be misused by speculators, but he did not call for a ban on using CDS to bet that a borrower's creditworthiness will deteriorate.

Some politicians have blamed the practice - which involves buying of CDS by speculators who do not own the bond being insured - for amplifying Greece's debt woes.

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On Wednesday Michel Barnier, the European commissioner in charge of financial market regulation, said he would propose rules to control such transactions, also known as naked buying.

Mr. Trichet said on Friday in a speech prepared for a conference at the European Commission in Brussels: "Certain financial instruments ... should not be misused in a speculative manner.

"We need more transparency in CDS markets, and so do investors," Mr. Trichet said.

"In this respect, a key priority in terms of enhancing the resilience of the CDS markets is the establishment of central counterparty facilities."

A CDS offers insurance against a default on corporate or government debt and contracts are mostly privately negotiated, or 'over-the-counter'.

Clearing of CDS trades in the EU and United States began on a voluntary basis last year and market leader ICE said in January its European clearing passed the trillion euro mark.

Clearing ensures that a trade is executed even if one side defaults and provides an electronic data trail for supervisors.

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The G20 group of leading countries agreed last year that as many contracts as possible in the world's $450-trillion derivatives sector, including CDS, should be standardized, centrally cleared and traded on an exchange where appropriate by the end of 2012.

The United States is already debating a bill to turn this pledge into law and the EU is due to come out with similar draft measures in the summer.

Mr. Trichet also said regulators need a new toolkit for co-ordinated action.

"I share the consensus at global level that regulators should be equipped with appropriate tools to be able to investigate and act in an effective and coordinated manner," Mr. Trichet said.

Critics of credit default swaps charge that speculators use the contracts to bet against countries for profit, which can lead bond yields higher and make it prohibitively expensive for debt-strapped countries like Greece to refinance their debt.

Some EU politicians have accused speculators of using CDS to bet on a Greek sovereign bond default.

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Last week, the head of France's market watchdog, Jean-Pierre Jouyet, was quoted as saying by French media that the European Union needed to take more action on financial regulation, particularly on CDS, or risk another crisis similar to Greece in six months' time.

Gary Gensler, the top U.S. derivatives regulator, told the European Parliament this week a ban would be unworkable and the focus should be on stopping manipulation, clearing and exchange trading.

While Mr. Trichet did not comment on whether some CDS should be banned, ECB Governing Council member Ewald Nowotny said earlier this month CDSs protecting debtors from a country defaulting on its debt were not sensible, and they could be banned.

"There is the discussion to ban CDS on sovereigns, and it would be only logical because no insurer in the world can bear the default risk of a sovereign," Mr. Nowotny said. "To write a CDS on Germany just doesn't make any sense at all.

Mr. Trichet also said global policy actions taken so far had already restored confidence in the short term.

"Going forward, we need to strengthen longer-term confidence, and that requires policy frameworks that will be robust against future challenges," he said.

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