Short selling, a recap at September 2010
Short selling restrictions and position disclosure continues to be high on the regulatory agenda in the wake of the economic crisis of 2008 and more recently, concern over market volatility in Eurozone sovereign debt, and the debate over the extent to which the use of credit default swaps (CDS) referenced to Eurozone sovereign debt, exacerbated this volatility.
On 18 May 2010, Germany’s regulator BaFin surprised the markets by introducing a naked short selling ban by way of General Decrees* on Eurozone sovereign debt admitted to; trading on a German regulated market, naked CDS trading linked to this debt (where the CDS is not being used to hedge default risk) and also naked short selling in the shares of certain financial institutions. BaFin cited the reason for this move as being that the “massive short selling of the debt securities concerned and the conclusion that uncovered CDS on credit default risks of euro zone countries were resulting in further excessive price movements which could result in further serious disadvantages for the financial market and could jeopardise the stability of the financial system as a whole”. It is interesting to note that no other EU countries followed suit.
This was followed by the European Commission’s proposals on a pan-European short selling regime in June 2010 which went beyond CESR’s March 2010’s proposals in certain respects, notably by proposing that the scope of the transparency requirements should include sovereign debt and CDS.
Here in the UK, the FSA implemented new short selling rules in FINMAR pursuant to its new statutory powers under the Financial Services Act 2010. These rules came into effect on 6 August 2010, but are temporary pending the conclusion of CESR’s and the European Commission’s work in this area, and the implementation of a pan-European short selling framework.
The following sections provide a recap and update of the position in Europe to date, and more detail on the new UK short selling regime.
*Note that BaFin’s General Decrees implementing the naked short selling ban were revoked with effect from 27 July 2010; very similar measures have been incorporated into the German Securities Trading Act, the key difference being that the naked short selling ban now applies to positions in shares of all companies admitted to trading on a German regulated market. In addition, the disclosure obligations introduced in March 2010 have also been incorporated into the Securities Trading Act, with two key differences; disclosure obligations will apply to all shares that are admitted to trading on a German regulated market and publications of short positions starting at 0.5% will no longer be in an anonymised form. The new disclosure obligations are due to take effect from 26 March 2012. Until then, the current disclosure obligations remain in effect.
Europe - The Story So far…
As you will recall from our April 2010 newsletter, CESR published a report in March 2010 (Click Here) setting out its proposals for a two-tier pan-European short selling regime, recommending that short positions of 0.2% or more creating an economic exposure to shares admitted to trading on an EEA regulated market and/or MTF as their primary market should be reported to the regulator, and positions of 0.5% or more should be reported to the market. In addition, further disclosures to the regulator and/or market would be required in respect of any upwards or downwards movement of 0.1%.
This report was followed in May 2010 by a technical details report (Click Here) which expanded on various items in the March proposals, including the calculation of changes in the net short position, netting and aggregation within an organisational structure, the mechanics of disclosure and exemptions from disclosure obligations.
CESR publish a consolidated list of measures that Members have taken in relation to short selling which was last updated on 19 July 2010 (Click Here).
In June 2010, the European Commission published its own pan-European short selling proposals (Click Here). In summary, the Commission is proposing the following:
- the new regime would have extraterritorial effect, and the notification and disclosure requirements would apply irrespective of where the holder of the short position is located
- naked short selling of shares would be banned, and relevant trading venues, central counterparties or settlement systems should have buy-in procedures which are triggered in the event that a short seller is unable to deliver the shares for settlement within a specified number of days after the trade date
- two transparency options were put forward:
- disclosure of every type of financial instrument admitted to trading on a regulated market or MTF in the EU, following CESR’s two-tier disclosure model
- disclosure of a specific set of financial instruments following CESR’s two-tier model, namely, EU shares and their derivatives, EU sovereign bonds and derivatives relating to those bonds, and CDS relating to EU sovereign issuers. Positions in EU sovereign bonds would only require notification to the regulator, not the market.
- exemptions for market makers in relation to naked short selling, transparency and buy-in procedures
- emergency powers for competent authorities to impose emergency short selling restrictions relating to the short sales of shares and bonds and a transaction which “creates, or relates to another financial instrument and the effect of or one of the effects of the transaction is to confer a financial advantage on the person in the event of a decrease in the price or value of a share or bond”. In addition, regulatory authorities would be able to restrict or prohibit the purpose for which persons may be able to enter into CDS transactions relating to EU sovereign debt or restrict the value of such transactions
- the European Securities and Markets Authority (ESMA) would have a facilitation and co-ordination role in relation to competent authorities’ use of emergency powers, focussing on ensuring that there is a consistent approach to the use of these powers.
The FSA issued a consultation paper in April 2010 (CP10/11 -Implementing Aspects of the Financial Services Act 2010 – Click Here), which set out its proposals for temporary short selling rules pending the finalisation of a European short selling framework. This was followed by the publication of feedback and final rules in CP10/18 in July 2010 (Click Here). These rules came into force on 6 August 2010. The short selling rules have been moved out of MAR therefore moving them outside of the scope of the market abuse regime and into a new Financial Stability and Market Confidence Sourcebook – FINMAR. Simultaneous to this, the FSA was granted new enforcement powers which enables it to request information and documents which it reasonably requires for determining whether a firm has breached the short selling rules, and it also has new powers in relation to imposing financial penalties or public censure for breaches of the rules.
There is little material change relating to firms’ disclosure obligations in the new rulebook, save the key ones set out below:
- in relation to rights issues, firms will now only have to disclose positions reaching, exceeding or falling below 0.25% in UK incorporated companies and non-UK incorporated companies where a UK prescribed market is the main or sole trading venue for trading in the company’s securities.
- the short selling FAQ’s are now no longer in force as all relevant material is now incorporated into the rules.
- the FSA have published a new disclosure form – TR5, which is available on its website (Click Here)