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Abstract
Following more than a year of wrangling, European parliamentarians managed to persuade the Polish presidency of the European Union to support tough restrictions on so-called 'naked' sovereign credit default swaps (CDS) -- the buying of protection on government debt as an outright short position. The deal, announced on October 18, was hailed as a great victory. "They say they think volatility in the CDS markets is driven by speculation, but the reality is the regulation is causing it." That regulation is the charge for credit value adjustment under Basel III. It uses CDS spreads to calculate counterparty exposure in derivatives trades, and requires banks to hold capital against that number. It also allows banks to mitigate the capital requirement by buying CDS protection. Dealers say countries that find themselves in the headlines may not be so blase. Everyone looks at the CDS and, as it rises, it reflects negatively on the issuer's name.