European governments are exploring ways to curb trade in credit default swaps but may have to settle for requiring greater disclosure rather than banning certain forms of speculation. France, Germany and Luxembourg say "speculators" - typically code for hedge funds - used CDS contracts to bet on Greece defaulting and send the euro lower.
Faced with such political pressure, the European Commission has called national supervisors, credit rating agencies, hedge funds and investors to meetings in Brussels on Friday to help it decide if European Union action is needed in the CDS market.
The US Justice Department is also investigating if hedge funds might have acted together in betting against the euro. Credit default swaps are privately-negotiated "insurance" contracts between two parties. Unlike normal insurance, the buyer can go "naked", not owning what is being insured, a situation regulators say is perverse.
Traders are waiting to see if regulators will go beyond jawboning and require buyers of sovereign CDS to own some underlying debt or deploy other means to quell volatility.
"In principle it would be feasible to design a scheme that would prevent financial institutions from being involved in the naked sale of CDS," said Karen Anderson of Herbert Smith lawfirm. Politicians like French Economy Minister Christine Lagarde and Eurogroup President Jean-Claude Juncker of Luxembourg have argued that the CDS tail is wagging the sovereign debt dog. Financial lawyers, industry officials and analysts say CDS contracts are a health check on the underlying asset and governments just can't stomach the truth of falling prices.
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