Germany banned risky bets on bonds, stocks and credit protection, stunning investors and setting euro zone markets up for a rough ride on Wednesday amid fears Berlin's attack on speculation will backfire.
Germany banned some trades in a strategy known as short selling to fight financial speculation, which it blames for much of Europe debt crisis. Analysts said, however, the move could do more harm than good, draining funds away from the euro zone and deepening risk aversion.
Some called it an act of desperation.
"Germany just switched off the financial lights in Europe," said a senior forex trader at a European bank in Singapore.
Germany's lack of coordination with any other countries, including euro zone members, underscored how the measures may backfire and so unsettle, rather than calm, markets already nervous about the debt crisis, analysts said.
"Germany's announcement ... dented risk appetite as it raises the question as to whether the German regulator knows something the market doesn't," Rabobank said in a note. "If there is a secret here, it can't possibly be a positive one."
The euro — not covered by the ban — was the first casualty of the move, hitting a fresh four-year low.
It is expected to become the sole focus of those investors bearish about Europe's battle to contain the debt crisis triggered by Greece.
"People who are afraid of betting against European assets due to regulatory concerns would move those bets against the euro since there is no ban on short-selling there," Dariusz Kowalczyk, chief investment strategist, SJS Markets in Hong Kong.
It was not clear whether other euro zone governments would follow Germany's lead, though Austria suggested it would seek to discuss a Europe-wide measure at a European Union finance minister's meeting on Friday.
"It is our intention to get this on the agenda of the finance ministers' task force meeting on Friday, aiming towards a European ban on naked short selling," the Financial Times quoted a finance ministry spokesman as saying.
The clampdown announced by Europe's biggest economy coupled with strengthening regulation in the United States were enough to trigger a selloff in Asian shares and metals on fears that too heavy-handed rules could stunt the global recovery.
The MSCI index of Asia-Pacific shares outside of Japan was down over 2 percent at a four-month low at 381.38 points. It has fallen about 4.7 percent since the start of the week.
Japanese bond dealers stopped quoting prices on European bonds in Tokyo to see how European markets react and investors piled into the safety of liquid U.S. Treasury bonds, Japanese government debt and gold.
In a sign that a 750 billion euro emergency debt package agreed by euro zone leaders last week failed to calm markets, banks stampeded the European Central Bank's fund draining operation, choosing the safety of deposits at the central bank over government bonds.
Analysts said a broader euro zone-wide ban could result in the drain of funds and business away from Frankfurt to London and other global financial centers.
Naked short selling of euro-denominated government bonds, credit default swaps based on those bonds, and shares in Germany's 10 leading financial institutions will be prohibited until March 31, 2011, a spokesman for the German finance ministry said.
Credit default swaps, a type of derivative known as CDS, insure against the risk of debt defaults.
"The ban takes effect at midnight," a Finance Ministry spokesman said, confirming what sources in Germany's ruling coalition had told Reuters earlier.
A coalition source said Chancellor Angela Merkel would formally announce the ban on Wednesday.
Short selling is a trade that bets a price will fall. Naked short selling is when a trader sells a financial instrument without first borrowing the instrument or ensuring that it can be borrowed, as would be done in a conventional short sale.
Germany's financial regulator said the move was "due to the extraordinary volatility in government bonds in the euro zone." Massive short-selling could have endangered the stability of the financial system, it said.
It was not clear how Germany could enforce the ban effectively in the debt and CDS markets, which stretch across national borders. Most European trade in CDS takes place in London.
In response to the global financial crisis and the euro zone's debt problems, the German government has been working on a bill to increase protection for investors and reduce wild swings in capital markets.
Under plans sketched out earlier this year, naked short-selling would be forbidden by law as threatening the stability of financial markets. An electronic system for reporting and publishing short sale positions would be set up, with sanctions to ensure compliance.
U.S. regulators are working on their own rules to curb stock trading when markets plunge uncontrollably, as happened on May 6 when the Dow Jones industrial average dropped some 700 points within minutes.
The plan was hastily crafted by the Securities and Exchange Commission and major U.S. exchanges and will be implemented as soon as mid-June, a source familiar with the plan told Reuters.
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