Short selling

Aims

The EU’s Regulation on Short Selling and certain aspects of credit default swaps came into force on 1 November 2012 with the aim of achieving the following:

  • increasing the transparency of short positions held by investors in certain EU securities;
  • reducing settlement risks and other risks linked with uncovered or naked short selling.
  • reducing risks to the stability of sovereign debt markets posed by uncovered (naked) CDS positions, while providing for the temporary suspension of restrictions where sovereign debt markets are not functioning properly;
  • ensuring Member States have clear powers to intervene in exceptional situations to reduce systemic risks and risks to financial stability and market confidence arising from short selling and credit default swaps; and
  • ensuring co-ordination between Member States and the European Securities Markets Authority (ESMA) in exceptional situations.


It will be applicable in EEA countries upon implementation of the Regulation under the EEA agreement.

Practical Effect

The new Regulation means that in relation to the short selling of shares and of sovereign debt instruments and the taking of sovereign credit default swaps positions the following requirements apply:

  • All those entering into short sales of shares must be covered by either having borrowed the instruments concerned, have arranged to borrow them; or have an arrangement with a third party who has confirmed that the share has been located i.e. naked short selling in shares is now banned;
  • All those entering into short sales of sovereign debt instruments must have borrowed the instruments concerned, have an agreement to borrow them, or have an arrangement with a third party who has confirmed that the share has been located or expects that the trade can be settled when due i.e. naked short selling in sovereign debt is now banned
  • All those entering into credit default swaps positions related to a sovereign issuer must have an underlying exposure to the risk of default of that sovereign issuer or of a decline in the value of the sovereign debt of that issuer i.e. naked sovereign CDS are now banned.
  • Central counterparties providing clearing services must ensure that there are adequate arrangements in place for buy-in of shares as well as fines where there is a settlement failure.
  • Mandatory transparency of net short positions:
    • significant net short positions in shares must be
      • reported to the relevant competent authorities when they at least equal to 0.2% of company issued share capital and every 0.1% above that;
      • disclosed to the publich when they at least equal to 0.5% of company issued share capital and every 0.1% above that.
    • significant net short positions in sovereign debt should be reported to the relevant competent authorities when reaching or crossing one of the thresholds published by ESMA for sovereign issuers– notification thresholds,
  • Exemptions are available for market making activities and authorised primary dealers;

According to the provisions of the Regulation, ESMA will have to provide for public access to certain types of information:

  1. Significant net short position notification thresholds for each sovereign issuer (Article 7(2));
  2. Links to central websites operated or supervised by competent authorities where the public disclosure of net short positions is posted (Article 9(4));
  3. The list of shares for which the principal trading venue is located in the third country (Article 16(2));
  4. A list of market makers and authorised primary dealers (Article 17(3));
  5. A list of existing penalties and administrative measures applicable in Member States (Article 41).

 

ESMA’s coordination role in exceptional circumstances

ESMA has been given the role of coordinating the scope and implementation of any proposed emergency measures by national competent authorities (NCA).  The system will function as follows:

  • The NCA notifies ESMA of its intention to take emergency measures, setting out the reasons for the action and the type of measures to be taken;
  • ESMA has 24 hours in which to issue an opinion on whether it considers the measure appropriate and proportionate to address the threat and also if the time duration is justified;
  • The opinion shall be published on ESMA’s website;
  • If a NCA takes measures despite a negative ESMA opinion it must then publish, within 24 hours, of the ESMA decision an explanation for doing so;
  • ESMA will regularly review emergency measures taken under the Regulation, at least every 3 months.


In addition, ESMA will have the power to coordinate the actions of NCAs by assessing the emergency measures one NCA is proposing to take and considering whether it should be expanded to other jurisdictions.

ESMA powers of intervention in exceptional circumstances

In exceptional circumstances ESMA can also decide to use its intervention powers directly and take the following emergency measures:

  • Prohibition or conditions on entering
    • into a short sale
    • into other transaction in a financial instrument that confers a financial advantage in case of decrease in value of another financial instrument (does not apply to sovereign debt and sovereign CDS)


For sovereign debt and sovereign CDS, in case of an emergency declared by the European Council, ESMA can take individual decision requiring NCAs to take actions.

ESMA has published a Questions and Answers (Q&A) document that clarifies the technical aspects of practical implementation of the Regulation.  To facilitate its work and provide useful assistance ESMA is inviting concerned market participants to submit their questions regarding practical implementation of the Regulation to the following email address: info@esma.europa.eu.  The document will be periodically updated following the receipt of new questions.

Please note that for the exact details and application of these requirements you should refer to the Short Selling Regulation and related delegated and implementing regulations.

Short selling links

Documents