The European Parliament voted Monday to stop investors from buying insurance for government debt if they don't own the underlying bond, as it seeks to fight financial speculation.
The Parliament's Monetary and Economic Affairs Committee endorsed changes to the proposals from the European Commission, the European Union's executive, on so-called credit default swaps, which have been blamed for pushing up borrowing costs for financially distressed countries like Greece.
Investors can buy credit default swaps for sovereign bonds in order to insure against the default of a country.
However, at the moment investors can also buy a CDS for a bond they don't own, basically betting that the cost for insurance will go up and they will make a profit.
The proposal now has to go to EU governments, which are divided over the Parliament's ban.
The Alternative Investment Management Association, which represents hedge funds around the world, opposed the Parliament's ban, saying there was no proof that uncovered credit default swaps have any effect on bond prices or push up borrowing costs.
"If a ban or restriction on entering into net short positions via sovereign CDS was to be enacted it would affect the efficient functioning of global debt markets and have far reaching and substantial negative consequences," AIMA's CEO Andrew Baker said in a statement ahead of the vote.
AIMA said CDS investment improves liquidity in the market and that investors who have an indirect exposure to sovereign debt _ for instance though business investments in a country _ should also be able to insure against a default.
The parliamentary committee _ meeting in Strasbourg_ also voted for a near-ban on so-called naked short selling. In a traditional short sale, an investor hopes to make a profit by borrowing a share, selling it and then buying it back at a lower price. In a naked short sale an investor bets on a drop in the share price without actually borrowing the underlying share _ a practice some regulators view as dangerous to market stability.
The committee on Monday endorsed rules that would force investors to "cover" their short sales within one trading day.
The European Parliament has been flexing its muscles on financial and economic regulation. It is also pushing to tighten limits on government debt and deficits, endorsing more automatic sanctions for overspending governments.
The Monetary Affairs Committee made more than 2,000 amendments to a proposed overhaul of the spending rules. Jean Claude Trichet, the president of the European Central Bank, last week called on the Parliament to make the rules more strict, after they were watered down bu EU governments last fall.
Trichet said harsher rules and sanctions are crucial to help avoid another debt crisis like the one that has already pushed Greece and Ireland into seeking multibillion euro bailouts.