EUROPE: Council agrees general approach on EU short selling and CDS

Wednesday May 18 2011

Further to the updates of 8 March and 9 May, the Council has set out its position with a view to negotiations with the European Parliament on a draft regulation aimed at introducing EU rules for EU short selling and certain aspects of credit default swaps. This follows widely reported discontent on the part of EU member state governments with the restrictive vote of the European Parliament on a draft EU regulation, in particular as regards credit default swaps trading.

The Commission`s draft regulation covers all types of financial instruments, providing for a response that is proportionate to the potential risks posed by EU short selling of different instruments. In particular, for shares of companies listed in the EU, it 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 proposed regime also provides for notification of significant positions in credit default swaps that relate to EU sovereign debt issuers.

The proposal requires that 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.

However, these restrictions would not apply to the EU short selling of sovereign debt if the transaction serves to hedge a long position in debt instruments of an issuer. Moreover, if the liquidity of sovereign debt falls below a specified threshold, the restrictions on uncovered EU short selling may be temporarily suspended by the relevant competent authority.

In exceptional situations that threaten financial stability or market confidence in a member state or the EU, the draft regulation provides that competent authorities have temporary powers to require further transparency or to impose restrictions on EU short selling and credit default swap transactions or to limit individuals from entering into derivative transactions. In such a situation, the European Securities Market Authority (ESMA) is given a coordination role to ensure consistency between competent authorities and to guarantee that such measures are only taken where it is necessary and proportionate to do so. ESMA is also given the power to take measures where the situation has cross-border implications. When it comes to EU short selling of sovereign debt instruments, however, ESMA would only be authorised to intervene after it has received the consent of the relevant competent authorities.

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