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Short Selling

Short Selling

EU Regulation on Short Selling and certain aspects of credit default swaps N 236/2012 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) Credit Default Swaps (CDS) positions, while providing for the temporary suspension of restrictions where sovereign debt markets are not functioning properly; and
  • 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.

Aim

The 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 short sales of shares must be covered by either having borrowed them, having arranged to borrow them; or have an arrangement with a third party confirming their location (i.e. naked short selling in shares is now banned);
  • All short sales of sovereign debt instruments must be covered either by having borrowed them, arranged to borrow them, or had an arrangement with a third party confirming their location or that the trade can be settled when due (i.e. naked short selling in sovereign debt is now banned);
  • All 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 public 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 must be reported to the relevant competent authorities when reaching or crossing one of the thresholds published by ESMA for sovereign issuers.

Exemptions are available for market making activities and authorised primary dealers.

National Competent Authorities - Intervention Powers

The SSR provides for a series of intervention powers for National Competent Authorities (NCAs), that can be summed up as follows:

  1. Temporarily restriction of short selling of a financial instrument further to a significant fall in price (so-called short-term ban). This measure cannot exceed the end of the trading day after the one in which the measure has been adopted. It can be extended for additional 2 trading days;                                                                                                                                                                                                                               
  2. Exceptional notification to the NCA and/or public disclosure of NSPs;                                                                                                                                                                                                                                       
  3. Exceptional notification to the NCA of any significant change in the fees lending in relation to certain financial instruments; and                                                                                                                                          
  4. Restrictions on short selling or NSPs of i)  identified financial instruments, ii) classes of financial instruments iii) all financial instruments (so-called long-term ban).

In order for a NCA to adopt any of the measure from 2 to 4, the following conditions apply:

  • serious threat to financial stability or to market confidence in the Member State concerned or in one or more other Member States;
  • the measure is necessary to address the threat and will not have a detrimental effect on the efficiency of financial markets which is disproportionate to its benefits;
  • they have obtained the consent of the relevant NCA for those financial instrument for which they are not the relevant competent authority; 
  • the intended measure should be notified to ESMA not less than 24 hours before the intended measure takes effect; and
  • duration of the measures cannot exceed 3 months and can be renewed for additional 3 months.

ESMA, which has been given the role of co-ordinating the scope and implementation of any proposed NCA emergency measures, shall then issue within 24 hours an opinion on whether:

                      i.        the proposed measure is necessary to address the exceptional circumstance;

                    ii.        there is a serious threat to financial stability or to market confidence in one or more Member States; and

                   iii.        the measure or proposed measure is appropriate and proportionate to address the threat and whether the proposed duration of any such measure is justified.

Where a NCA takes measures despite a negative ESMA opinion it must publish on its website within 24 hours an explanation for doing so.

ESMA will regularly review emergency measures taken under the Regulation, at least every 3 months.

ESMA has the power to coordinate the actions within NCAs by assessing the emergency measures one NCA is proposing to take and considering whether it should be expanded to other jurisdictions.

ESMA Intervention Powers

In exceptional circumstances ESMA can also decide to use its intervention powers directly and prohibit or put conditions on short sales or 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). Other than for sovereign debt and sovereign CDS, in case of an emergency declared by the European Council, ESMA can make an individual decision requiring NCAs to take actions.

The SSR provides for a series of intervention powers for ESMA, that can be summed up as follows:

  1. require that persons notify a NCA or disclose to the public their NSPs in relation to a specific financial instrument or class of financial instruments
  2. introduce restrictions on short selling or NSP on financial instruments 

In order for ESMA to adopt such intervention powers:

a.    the measures should address a threat to the orderly functioning and integrity of financial markets or to the stability of the whole or part of the financial system in the Union

The level 2 has clarified that such threat means:

  • any threat of serious financial, monetary or budgetary instability concerning a Member State or the financial system within a Member State when this may seriously threaten the orderly functioning and integrity of financial markets or the stability of the whole or part of the financial system in the Union;
  • the possibility of a default by any Member State or supra- national issuer;
  • any serious damage to the physical structures of important financial issuers, market infrastructures, clearing and settlement systems, and supervisors which may seriously affect cross-border markets in particular where such damage results from a natural disaster or terrorist attack when this may seriously threaten the orderly functioning and integrity of financial markets or the stability of the whole or part of the financial system in the Union;
  • any serious disruption in any payment system or settlement process, in particular when it is related to interbank operations, that causes or may cause significant payments or settlement failures or delays within the Union cross-border payment systems, especially when these may lead to the propagation of financial or economic stress in the whole or part of the financial system in the Union;

b.    there are cross-border implications

c.     no NCA has taken measures to address the threat or one or more of the competent authorities have taken inadequate measures

d.    ESMA should consult the ESRB and, where appropriate, other relevant authorities

e.    ESMA should notify the NCAs concerned by the measure (at least 24 hours before the measure takes effect, except in exceptional circumstances where notice can me shorter)

Additionally, ESMA should assess whether its measure:

  • addresses the threat or significantly improves the ability of NCAs to monitor the threat (appropriateness)
  • does not create a risk of regulatory arbitrage
  • does not have a detrimental effect on the efficiency of financial markets, (including by reducing liquidity in those markets or creating uncertainty for market participants) that is disproportionate to           the benefits of the measure (proportionality)

ESMA's Policy Role

Technical Standards

The Regulation required ESMA to draft Regulatory and Implementing Technical Standards (RTS and ITS) to further detail:

  • the notification and disclosure requirements with regard to net short positions, the details of the information to be provided to ESMA in relation to net short positions and the method for calculating turnover to determine exempted shares;
  • the means for public disclosure of net position in shares, the format of the information to be provided to ESMA in relation to net short positions, the types of agreements, arrangements and measures to adequately ensure that shares of sovereign debt instruments are available for settlement and the dates and period for the determinidation of the principal venue for a share; and
  • the method of calculation of the fall in value for liquid shares and other financial instruments.

Technical advice

In order to assist the European Commission (EC) to draft and adopt a delegated act supplementing the Regulation with regard to: definitions, the calculation of net short positions, covered sovereign credit default swaps, notificiation thresholds, liquidity thresholds for suspending restrictions, significant falls in the value of financial instruments and adverse events, ESMA was mandated to provide technical advice. 

Guidelines

To enhance, clarify and foster convergence in the implementation of the exemption for market making activities and primary market operations, ESMA has issued guidelines to competent authorities and financial market participants.  Information about the ESMA guidelines process, their status and related documents is available in the Guidelines and Technical Standards page.

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

​Exceptional Circumstances

Furthermore in exceptional circumstances, ESMA has been given the role to co-ordinate the scope and implementation of any proposed emergency measures by NCAs.  The system will function as follows:

  • The NCA notifies ESMA of its intention to take emergency measures, setting out the reasons for such measures;
  • Within 24 hours ESMA issues an opinion on whether the measures and time duration are appropriate and proportionate to address the threat, and publishes such opinion its website;
  • If a NCA takes measures despite a negative ESMA opinion it must publish an explanation for doing so, within 24 hours of such opinion
  • ESMA will regularly review emergency measures taken under the Regulation, at least every 3 months.

ESMA has the power to coordinate the actions within NCAs by assessing the emergency measures one NCA is proposing to take and considering whether it should be expanded to other jurisdictions.

In exceptional circumstances ESMA can also decide to use its intervention powers directly and prohibit or put conditions on short sales or 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). Other than for sovereign debt and sovereign CDS, in case of an emergency declared by the European Council, ESMA can make an individual decision requiring NCAs to take actions.

ESMA Q&As

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.