Introduction

Effective as of 19 May 2010 (midnight), the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht - BaFin) issued three decrees to stabilise the markets. The reasons are the extraordinary volatility of debt instruments issued by countries of the Euro zone and the exceeding spreads of credit default swaps (CDS) relating to the default of certain countries of the Euro zone.

Ban on naked short sales in debt instruments issued by countries of the Euro zone

The BaFin banned naked short sale transactions in debt instruments that are:

  • issued by a country that adopted the Euro; and
  • denominated in Euro; and
  • listed on a German regulated market.

A transaction shall be deemed a “naked” short sale, if the seller - at the time it enters into the transaction - is not the owner of the respective securities, nor does it have an enforceable claim or a right in rem for delivery of such securities.

Naked short sales in debt instruments issued by states of the Euro zone are allowed if they serve hedging purposes for existing positions.

Market makers that have contractually agreed to buy and sell financial instruments on an ongoing basis on their own account are exempted from the short selling ban if the transaction is required to fulfil such contractual obligations. Transactions that are concluded by market participants to fulfil a fixed-price transaction with a client are also exempted. Further exemptions can be granted by the BaFin in the BaFin’s discretion; this requires an application in writing.

Prohibition of CDS relating to debt of any state of the Euro zone

The BaFin prohibited entering into CDS relating to debt of any state of the Euro zone. This includes CDS that are imbedded into a credit linked note or a total return swap. Furthermore, in case a CDS relates to a basket of obligations, it is sufficient if one of the basket obligations is an obligation of a state of the Euro zone.

Only “naked” CDS are covered by the ban. Excluded are therefore transactions that effect (from an economic perspective) a not immaterial reduction of the credit risk of

  • existing positions in debt in a country of the Euro zone; or
  • another financial instrument that decreases value if the credit rating of the respective country of the Euro zone is down graded.

Exempted from the ban are transactions entered into to settle positions that have been concluded before the ban came into effect.

Ban on naked short sales in the most important German financial institutions

The BaFin banned naked short sale transactions of shares in the following German companies: Aareal Bank AG, Allianz SE, Commerzbank AG, Deutsche Bank AG, Deutsche Börse AG, Deutsche Postbank AG, Generali Deutschland Holding AG, Hannover Rückversicherung AG, MLP AG, Münchener Rückversicherungs-Gesellschaft AG.

The same definition of “naked” short sale applies as set out above for the short sale of debt instruments. Furthermore, the exemptions for market makers and fixed-price transactions also apply for the short sale of shares in the said German financial institutions.

Who is subject to the decrees?

The decrees and the BaFin website are silent on the question which persons are subject to the bans. The decrees therefore include “everyone”; however, the regulatory authority of the BaFin is limited to Germany. It is therefore expected that the BaFin will issue an explanatory note on the applicability to foreign market participants shortly.

The decrees on short sales in debt instruments and shares in financial institutions generally apply to all market participants inside and outside Germany; however, such decrees are limited to financial instruments that are listed on a regulated market in Germany.

The CDS decree generally affects all persons in Germany - financial institutions and other persons - but not directly foreign market participants. However, a German person would not be allowed to assist foreign market participants in entering into CDS transactions banned by the decree. The BaFin will likely take the view that it is decisive where the CDS are entered into. The CDS ban would therefore not be applicable if CDS are entered into outside of Germany by two non-German parties. The ban would apply, however, if one of the parties entering into the CDS is based in Germany.