EUROPE: Commission announces proposals for EU short selling and CDS

Friday September 17 2010

The European Commission has adopted a proposal for a regulation on EU short selling and certain aspects of Credit Default Swaps. Its main objectives are to create a harmonised framework for coordinated action at European level, increase transparency and reduce risks. The new framework will mean regulators, both national and European, have clear powers to act when necessary, whilst preventing market fragmentation and ensuring the smooth functioning of the internal market.

The proposal will increase transparency for regulators and markets, and make it easier for regulators to detect risk in sovereign debt markets. Regulators will also gain clear powers to restrict or ban short selling in exceptional situations, in coordination with the new European Securities and Markets Authority.

The proposal requires that all share orders on trading venues be marked as `short` if they involve a short sale, so that regulators know which transactions are short. In addition, investors will have to disclose significant net short positions in shares to regulators at one threshold (0.2% of issued share capital), and to the market at a higher threshold (0.5%). Concerning sovereign bonds, regulators will be better able to detect possible risks to the stability of sovereign debt markets by receiving data on short positions, including those obtained through sovereign Credit Default Swaps.

The proposal also gives national regulators clear powers in exceptional situations to temporarily restrict or ban short selling in any financial instrument, subject to coordination by ESMA (which should be operational from January 2011 subject to agreement by the European Parliament). ESMA is also given the power to issue opinions to competent authorities when they intervene in exceptional situations.

In line with the new supervision framework, ESMA will have the possibility, when certain conditions are fulfilled, to adopt temporary measures itself, with direct effect, restricting or prohibiting short selling. In addition, if the price of a financial instrument falls by a significant amount in a day, national regulators will have the power to restrict short selling in that instrument until the end of the next trading day.

The proposal also requires that to enter a short sale, an investor must have borrowed the instruments concerned, entered into an agreement to borrow them, or have an arrangement with a third party to locate and reserve them for lending so that they are delivered by the settlement date [at the latest 4 days after the transaction].

Trading venues must ensure that there are adequate arrangements in place for buy-in of shares or sovereign debt, as well as fines and a ban on short selling, where there is a settlement failure.

The proposal now passes to the European Parliament and the Council for negotiation and adoption. Once adopted the regulation would apply from 1 July 2012.

Click on the above link for more details.