Supervision

Short selling regulation - came into effect on 1 July 2017

What is the short selling regulation?
The short selling regulation is a regulation of the European Union (EU)No 236/2012 of 14 March 2012 on short selling and certain aspects of credit default swaps. The short selling regulation consists of Regulation (EU) No. 236/2012 as well as the Implementing Regulations and Delegated regulations that implement the so-called technical standards. Technical standards may be RTS (e. Regulatory technical standards) or ITS (e. Implementing technical standards) regarding the further implementation of short-selling regulation. The short selling regulation has four technical standards, Implementing Regulation (EU) 827/2012 and delegated regulations (EU). 826/2012, (EU) 918/2012 and (EU) 919/2012.

A new framework regarding short selling of financial instruments and transactions in credit default swaps was introduced with the short selling regulation. The regulation requires holders of net short positions in shares or sovereign debt to make notifications once certain thresholds have been breached. It also outlines further restrictions on investors entering into uncovered short positions in shares or sovereign debt. The competent authorities are given powers to suspend or restrict short selling of such transactions under certain circumstances.

The Regulation is aimed to achieve the following:

  • increasing the transparency of short positions held by investors in certain EEA securities,

  • reducing settlement risk 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

  • ensuring that the competent authorities 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,

  • ensuring co-ordination between Member States and the European Securities and Markets Authority (ESMA) in exceptional situations.

Notification of net short positions and uncovered positions in credit default swaps (CDS)

According to the regulation individuals and legal entities are required to report net short positions in shares and sovereign debt instruments to the competent authorities as soon as they go above or below a certain level. It is also necessary in some cases to report exposure to uncovered sovereign credit default swaps (CDS).


Net short positions in shares
A notification must be made to the competent authorities when a net short position exceeds or falls below the limit of 0.2% of the issued share capital of the company that has had its shares admitted to trading on a regulated market or MTF. In addition a notification must be made every time a net short position is increased by 0.1% in excess of the aforementioned 0.2% limit. Notification must be made public if the net short position in shares exceeds 0.5% of the issued share capital of a company and for each 0.1% above that. Notifications must be made privately or in public when a net short position falls below the aforementioned limits.

Figure 1: Threshold for reporting net short positions in shares

Net short positions in sovereign debt instruments
A notification must be made to the competent authorities when a net short positions in sovereign debt instruments exceeds or falls below certain limits. Where the total amount of outstanding debt of a state is in the range of 0 to 500 billion euros, the notification limit is 0.1%. Where the total amount of outstanding debt of a state is over 500 billion euros or where there is a market with futures for the issued sovereign debt instruments of that State, and the market is considered liquid, the notification limit is 0.5%. A notification must be made each time the net short position is increased by 0.05% above the 0.1% level and when the net short position is increased by 0.25% above the 0.5% level. The threshold for Iceland is 0.1%.

Figure 2: Threshold for reporting net short positions in sovereign debt instruments

ESMA has published a list of the different thresholds for each Member State in these instruments.


Positions in uncovered sovereign credit default swaps
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). There are certain exemptions for market-making activities and primary market operations. When an exemption is granted, a notification should be made in accordance with the requirements for notification for sovereign debt instruments.


Restrictions on uncovered short sales


Short selling of shares and sovereign debt instruments
According to the provisions of the short selling regulation an uncovered short selling of shares and sovereign debt instruments is banned. When entering into a short sale, the investor should have the financial instruments available, or be ready to take appropriate measures to ensure that it will be available on the agreed settlement date of the transaction. The requirements can be met in three ways:

  • borrow the shares or the sovereign debt instruments, or make alternative provisions resulting in a similar legal effect,

  • enter into an agreement to borrow the share or the sovereign debt or have another absolutely enforceable claim under contract or property law to be transferred ownership of a corresponding number of securities of the same class so that settlement can be effected when it is due,

  • have an arrangement with a third party under which that third party has confirmed that the share has been located and has taken measures vis-á-vis third parties necessary for the natural or legal person to have a reasonable expectation that settlement can be effected when it is due.

These restrictions do not apply if the transaction serves to hedge a long position in debt instruments of an issuer, the pricing of which has a high correlation with the pricing of the given sovereign debt.

Sovereign credit default swaps

A natural or legal person may enter into sovereign credit default swap transactions only where that transaction does not lead to an uncovered position in a sovereign credit default swap as referred to in Article 4 of regulation 236/2012.

A natural or legal person shall be considered to have an uncovered position in a sovereign credit default swap where the sovereign credit default swap does not serve to hedge against:

  • the risk of default of the issuer where the natural or legal person has a long position in the sovereign debt of that issuer to which the sovereign credit default swap relates; or

  • the risk of a decline of the value of the sovereign debt where the natural or legal person holds assets or is subject to liabilities, including but not limited to financial contracts, a portfolio of assets or financial obligations the value of which is correlated to the value of the sovereign debt.

A competent authority may temporarily suspend restrictions in uncovered sovereign credit default swaps given that its sovereign debt market is not functioning properly and that such restrictions might have a negative impact on the sovereign credit default swap market.

Buy-in procedures

The regulation requires that a central counterparty in a Member State that provides clearing services for shares shall ensure that procedures are in place, which are automatically triggered for the buy-in of shares to ensure delivery for settlement, where a natural or legal person who sells shares is not able to deliver the shares for settlement within four business days after the day on which settlement is due.

Where the buy-in of the shares for delivery is not possible, an amount is paid to the buyer based on the value of the shares to be delivered at the delivery date plus an amount for losses incurred by the buyer as a result of the settlement failure. The natural or legal person who fails to settle reimburses the central counterparty all amounts paid.

Exemption for market making activities and primary market operations

Market makers and authorised primary dealers are exempt from the reporting obligation and the ban on uncovered short position in shares, sovereign debt and the ban from having an uncovered short position in sovereign credit default swaps.

If a market maker or an authorised primary dealer have an uncovered short position in sovereign credit default swaps and they go over the limit that are set for that type of position, they need to report them in accordance with the requirements set forth in the regulation.

These exemptions shall apply only where the natural or legal person concerned has notified the competent authority of its home Member State in writing that it intends to make use of the exemption. The notification shall be made not less than 30 calendar days before the natural or legal person first intends to use the exemption. The competent authority may prohibit the use of the exemption if it considers that the natural or legal person does not satisfy the conditions of the exemption. Subsequently the competent authority can prohibit the use of the exemptions if it becomes aware that there have been changes in the circumstances of the natural or legal person so that it no longer satisfies the conditions of the exemption.

POWERS OF INTERVENTION OF COMPETENT AUTHORITIES

Under exceptional circumstances where financial stability or market confidence is threatened the competent authority can step in and halt or limit short selling of financial instruments and sovereign credit default swaps. Under these circumstances the competent authority may:

  • require natural or legal persons who have net short positions in relation to a specific financial instrument or class of financial instruments to notify it or to disclose to the public details of the position where the position reaches or falls below a notification threshold fixed by the competent authority,

  • require natural or legal persons engaged in the lending of a specific financial instrument or class of financial instruments to notify any significant change in the fees requested for such lending,

  • prohibit or impose conditions relating to natural or legal persons entering into a transaction other than a short sale which creates, or relates to, a financial instrument and the effect or one of the effects of that transaction is to confer a financial advantage on the natural or legal person in the event of a decrease in the price or value of another financial instrument,

  • restrict the ability of natural or legal persons to enter into sovereign credit default swap transactions or may limit the value of sovereign credit default swap positions that those persons are permitted to enter into.

The competent authority also has the power to restrict short selling of financial instruments temporarily in the case of a significant fall in price, where the price of a financial instrument on a trading venue has fallen significantly during a single trading day in relation to the closing price on the previous trading day. The fall in value shall be 10% or more in the case of a liquid shares. This measure shall apply for a period not exceeding the end of the trading day following the trading day on which the fall in price occurs. The competent authority may extend the measure under certain circumstances. That extension shall not exceed 2 trading days after the end of the second trading day.

Powers of ESMA

ESMA and the EFTA Surveillance Authority shall perform a facilitation and coordination role in relation to measures taken by the competent authorities. In particular ESMA shall ensure that a consistent approach is taken by competent authorities regarding measures taken, especially regarding where it is necessary to use powers of intervention, the nature of any measures imposed and the commencement and duration of such measures.

ESMA and the EFTA Surveillance Authority also have intervention powers in exceptional circumstances.

Further details

Further details on the short selling regulation can be found at ESMAs website (https://www.esma.europa.eu/regulation/trading/short-selling ). The following e-mail address, skortsala(a)fme.is, has been designated for inquiries regarding the regulation.

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