Gaps in securities and derivative regulation in Europe create the possibility of "regulatory arbitrage," said John L. Langton, chief executive of the International Securities Market Association, a self-regulatory body that oversees the Eurobond market.
A report issued Aug. 18 by the Zurich-based ISMA found that regulators, with the exception of France, have neglected the relationship between securities lending and repurchase agreement markets, making it difficult to hedge securities.
Derivatives on individual securities are virtually impossible to hedge without the repo market, the report said. Yet regulators in Germany, the United Kingdom and elsewhere have created barriers to domestic repo markets, forcing investors to go to an unregulated "Euro repo" market.
In the report, the organization called for development of an international framework for securities lending.
Also, the report called for obtaining the permission of a company before an exchange grants a listing for an issue exceeding 5% of a company's capital.
The report also warned that investors can engage in insider trading through over-the-counter derivatives.
Such trades usually are reported in aggregate to banking authorities, which can make insider trading hard to detect.
The report also found that hedge funds were not wholly responsible for the bear bond market earlier this year, but the fall was due to fundamental factors.
Blaming the hedge funds for the collapse of the bond market "would be a case of shooting the messenger," said Julian Walmsley, one of the co-authors of the study.