19/05/2011

Towards harmonised EU rules on short selling

On 17 May the Economic and Financial Affairs Council, meeting in Brussels, agreed on the general approach on a draft Regulation on short selling and certain aspects of credit default swaps. This agreement is an intermediate step in the decision-making process that gives the Presidency a mandate to start negotiations on the regulation with the European Parliament.

<p>© Fotolia</p>

© Fotolia

The draft regulation is aimed at harmonising the member states' rules on short selling in order to eliminate the divergences between them and to ensure the smooth functioning of the internal market. It introduces common EU transparency requirements and harmonises the powers that regulators may use in exceptional situations, i.e. where there is a serious threat to financial stability or to market confidence.

Transparency rules

For shares of companies listed in the EU, the regulation creates a two-tier model for transparency of significant net short positions: while at a lower threshold, notification of a position must be made privately to the regulator, at a higher threshold, positions must be disclosed to the market.

For sovereign debt, significant net short positions relating to issuers in the EU would always require private disclosure to regulators.

The text also provides for notification of significant positions in credit default swaps that relate to EU sovereign debt issuers.

What is short selling?

Short selling is a practice whereby natural or legal persons sell a security that they do not own, but that it is promised to be delivered, with the intention of buying it back later. If the security price drops, the short sellers, after having bought back the securities in question, profit from the price difference.

Short selling is a common practice in most financial markets, and although it most often occurs in share trading, is not unusual in the selling of other types of financial instruments, for example, government bonds.

Short selling could roughly be divided into two types: covered short selling, where the seller has borrowed the security, or made arrangements to ensure they can be borrowed before the short sale is done, and uncovered (or naked) short selling, where at the time of the short sale the seller has not borrowed the securities or ensured they can be borrowed.

Restrictions for uncovered short selling

According to the proposal, anyone entering into a short sale must at the time of the sale have borrowed the instruments, entered into an agreement to borrow them or made other arrangements to ensure they can be borrowed in time to settle the deal. This rule is aimed at mitigating the increased risks that uncovered short sales pose.

These restrictions do not apply to the short selling of sovereign debt if the transaction serves to hedge a long position in debt instruments of an issuer. Furthermore, the restrictions on uncovered short selling may be suspended for some time by the relevant competent authority, if the liquidity of sovereign debt falls below a specified threshold.

Powers accorded to regulators

The rules provide that in exceptional situations competent authorities should have temporary powers to require further transparency or to restrict short selling and credit default swap transactions.

In such a situation the European Securities Market Authority (ESMA) would coordinate action between competent authorities and ensure that measures are truly necessary and proportionate. ESMA is also given powers to take measures where the situation has cross-border implications.

However, in the short selling of sovereign debt instruments, the ESMA will be authorised to intervene only with the consent of the relevant competent authorities.

 

More information:
Press release (pdf)
Press conference webcast

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