International regulators serve a few chasers: global short selling developments, March 2010

Here in the UK, the FSA published a Discussion Paper in February 2009 setting out its proposals for a longer-term short selling regime.  While concluding that banning such activity was not warranted, the FSA noted that it would be highly desirable to find international consensus in this area. 2010 has so far witnessed a flurry of activity in Europe, the US and Hong Kong in regard to short selling. These events to date are summarised below.

Europe/CESR

After a significant number of Committee of European Securities Regulators ("CESR") members took emergency measures to restrict short selling due to turbulent market conditions in the autumn of 2008, CESR developed a consolidated list providing an overview of the situation across Europe, updating it when members made changes in their short selling measures (Click Here).  In addition, CESR also launched a policy review, with the aim of formulating pan-European standards for short selling. 

In July 2009, CESR issued its consultation setting out “minimum harmonisation” proposals.  The consultation closed on 30 September 2009 and subsequently, on the 3rd March 2010, CESR published its recommendations for a pan-European disclosure regime for net short positions in shares. These recommendations should eventually allow investors to follow the same requirements for all shares admitted to trading on an EEA regulated market and/or Multilateral Trading Facility (MTF) whose primary market is Europe.

The suggested threshold for reporting to the relevant competent authority is 0.2% (based on issued share capital) with further disclosures triggered by steps of 0.1%. Once 0.5% is reached the investor would also have to disclose the position to the market as a whole and continue to disclose to the competent authority and market upon any further 0.1% increases.

This disclosure requirement will apply to exchange traded and OTC derivatives as well as cash positions. Positions are to be aggregated with short and long positions netted off.  Disclosures are to be made on the trading day following the day a threshold is crossed. Market making activity is exempt from these disclosure requirements.

So what happens next?  CESR considers that there should be new European legislation in this area, by means of a new Directive or Regulation.  We also understand that the European Parliament is planning an own initiative report on short selling.  In any event, the CESR recommendations must be adopted officially by the competent authorities of each EEA country before they come into force in the jurisdiction in question.  In the UK, the FSA must normally consult the industry before introducing any new regulatory requirements so any adoption of CESR procedures by FSA will take some time. 

The German regulator, BaFIN, however, has partially adopted the CESR rules already.  Its current stance is summarised below;

• disclosure of net short selling positions held in any of 10 selected financial stocks (primarily, banks) which amount to 0.2 % or more of the issued share capital of that company

• further notification, where such a position is reached, exceeds or falls below a further 0.1 %

• BaFin to publish - in anonymised form – a short position which reaches or exceeds 0.5 %.

• disclosure requirements apply to covered and ‘naked’ short sales and to all transactions resulting in economic exposure to a particular share(s), so that derivatives (exchange-traded or OTC) are covered.  Exemptions apply to market makers, to the extent that the transaction is required for performance of their contractual obligations.

The German requirements will come into force on 25 March 2010 and will initially apply until and including 31 January 2011.

USA

On 24 February 2010, the Securities and Exchange Commission (SEC) voted 3:2 to adopt a new rule to place restrictions on short selling when a stock is experiencing significant downward price pressure.  The measure is intended to promote market stability and preserve investor confidence.

Rule 201, or the “Alternative Uptick Rule”, imposes restrictions on short selling only when a stock has triggered a circuit breaker by experiencing a price decline of at least 10 percent from the prior day's closing price.  At that point, short selling would only be permitted if the price of the security is above the current national best bid. This would apply to short sale orders in that security for the remainder of the day as well as the following day.

The rule generally applies to all equity securities traded on an exchange or in the over-the-counter market.

The new rule will become effective 60 days after publication of the SEC’s adopting release, which has not yet been issued, in the Federal Register and there will be a six-month implementation period after the rule becomes effective. 

Hong Kong

The Securities and Futures Commission (SFC) has updated its short selling requirements with reporting thresholds lower than other international regulators.  However, they have longer reporting windows and no requirement to report derivatives.  Draft legislation is expected to be finished by the end of quarter two of 2010 with the end of quarter three being targeted for implementation of the below requirements:

• the threshold for reporting is 0.02% of issued share capital or if the value of the position is equal to or exceeds HK$30 million (whichever threshold is reached first)

• the reporting obligation is at fund level (although the manager can report on behalf of each fund managed)

• there are no exemptions for any short selling parties (requirements apply to market makers)

• the SFC retains discretion to change the reporting requirements in "contingency situations" (the scope of which will be set out in the secondary legislation, to be consulted upon)

• flagging (for all short sale orders) remains unchanged and close out indicators will not be introduced

• the obligation for computation and reporting is on short sellers (or another party duly authorised by them)

• reporting is on cash positions only – i.e. derivatives are excluded (at inception of the reporting regime, at least - any proposal to include them later will be the subject of fresh consultation)

• reporting requirements will only apply to stocks in the Hang Seng Index, the H-Shares Index and other financial stocks (so that as at 15 January 2010, the short positions of shares of a total of 100 listed companies (about 70% of market capitalisation of the stock market as at 31 December 2009 and about 80% of the total short selling turnover during 2009) will be subject to the reporting requirements)

• calculation for reporting is on a weekly basis (as at the last trading day of each week)

• reporting must be by the second business day of the following week and weekly reporting must continue until the short position falls below both the thresholds

• public reporting will be made by the SFC on an aggregate basis per stock and one week later (such aggregate reporting will begin a few months after the regime is implemented, to allow for any initial reporting issues/ irregularities)

9 March 2010

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