BRUSSELS, Nov 9 (Reuters) - European Union plans to curb abusive trading in naked sovereign credit default swaps should be hardened into an outright ban, a senior EU lawmaker responsible for guiding the plans through the EU assembly said on Tuesday.
Sovereign CDS contracts are like insurance contracts against the default on a government's debt.
Naked or uncovered selling of such contracts came under fire from policymakers when Greek government bonds sank in value earlier this year, prompting a EU-backed rescue.
Naked selling of sovereign CDS is when the buyer, such as a hedge fund, is shorting or taking a bet on a fall in the price of the underlying government bond it does not own.
The bloc's executive European Commission unveiled a draft law in September to increase transparency and limit abusive shortselling across all financial instruments. [ID:nLDE68E18S] [ID:nLDE68E1KP]
"I would say we should have a ban on uncovered CDS," said Pascal Canfin, a French Green Party member of parliament's economic affairs committee who is steering the draft law through the assembly.
Naked CDS selling was speculative and added nothing to the real economy, Canfin told the committee.
The European Parliament has joint say with EU governments on the draft law's final shape.
Hedge funds and banks point out that the sovereign CDS market is tiny compared with the size of government bond markets and it would be hard for the tail to wag the dog.
Policymakers are only attacking the sector because it was revealing uncomfortable truths such as the huge debt some governments are saddled with, they say.
The aim of the law is to increase transparency in naked or short selling of stocks and derivatives like CDS with sanctions for abuses, including a temporary ban.
Canfin found some support for a tougher regime.
"It's clear certain market practices must not be defended and here I am talking about this naked shortselling concept," said Luxembourg Socialist Robert Goebbels.
DON'T KILL THE CANARY
Swedish Liberal lawmaker Olle Schmidt questioned whether tackling shortselling was a priority for European citizens and that Germany's unilateral ban on naked CDS selling earlier this year caused problems for other countries.
"Come up with examples that naked shortselling has been bad... It could be hampering the market if we are banning it," Schmidt said.
British centre-right member Syed Kamall said CDS markets acted as "canaries in a mine", helping to identify overinflated asset prices and provided liquidity to financial markets.
"I tend to ask why do we need this regulation," Kamall said.
Canfin said the burden of requiring short sales to be marked so that regulators can identify them could be spread out over a few years, giving banks time to update their IT systems.
The committee aims to vote as early as February 7 as lawmakers are keen not to lag EU states in their efforts to reach a deal ahead of meshing the two positions.
The committee, which has over 40 members, revealed deep splits over the need and content of the draft law, signalling some tough bargaining ahead.
Goebbels said he would be very surprised if governments reached a deal among themselves by early next year as their working groups were not making much progress.