Late on 23 September, FSA updated its short-selling rules and FAQs.
New rules taking effect from 24 September clarify that:
- the market maker exemption from the short-selling prohibition is not linked to the normal Glossary definition of market maker; and
- parents of UK banks and insurers fall within the definition of "UK financial sector company" only where the group to which the parent and subsidiary belong is one whose main business is financial services.
FSA's FAQs (which do not amount to formal guidance) have been refined following intense discussions with market participants.
The definition of market maker is expanded so as also to include firms which deal "in a way that ordinarily has the effect of providing liquidity on a regular basis to the market on both bid and offer sides of the market in comparable size." However "Trading in circumstances other than genuinely for the provision of liquidity is not exempt".
This addition clearly widens the previous definition, but FSA emphasises that only trading undertaken genuinely in the capacity of market maker is exempt.
FSA allows "a certain level of flexibility…in line with existing general levels of business". This approach is designed to enable bona fide market makers to continue hedging on a flexible, portfolio basis, without automatically being regarded as position-takers by the FSA where hedging is inexact. FSA would expect market makers to hold significant short positions only for short periods and this may have practical ramifications for some firms.
FSA has clarified that:
- where a fund manager operates on a non-discretionary basis, the prohibition and the disclosure requirements apply to the client and not the manager;
- where the fund manager operates on a discretionary basis, however: m the prohibition applies to the client (where the client is a separate legal entity); but
- the disclosure requirement applies to the client in respect of its own position; and
- the disclosure requirement also applies to the manager in respect of the aggregate position of its discretionary clients.
This effectively means the prohibition does not apply in respect of a discretionary manager's aggregated client positions. Previously this had been thought to be the case and it had raised serious concerns for fund managers who would have been unable to fulfil their obligations to their clients as a result.
FSA has made more detailed and considered remarks on the treatment of indices and baskets in calculating whether a firm has a net short position in UK financial sector companies.
An index must be taken into account where it is made up entirely or "predominantly" of UK financial sector companies.
As a general rule, other indices are not included, but if a firm uses a combination of a short index trade and hedges in all the stocks in the index, other than on the UK financial sector components of the index, it will have manufactured a short position on the UK financial sector companies and that short position will be included in the calculation of the firm's net short position.
Some uncertainty remains about the treatment of long positions on an index, however.
Transfer of positions
The prohibition does not catch transfers of positions to new counterparties on the same terms, although any net short position is subject to the disclosure requirements.
Application to derivatives
Derivative trades that are delta neutral or delta positive when entered are allowed, but where a rolling derivative position expires, the delta position should not create a new overall net short position.
Issuers of convertible bonds are not short-selling for these purposes, and it is possible to hedge a long position in a UK financial sector company’s convertible bonds by taking a short position in the company's equity, so long as the trade does not create a new or increased net short position.