New measures by the UK FSA banning the active creation or increase of net short positions in publicly traded financial companies came into effect at 0.01 a.m. on Friday 19 September. The effect of the measures is to:

  • prohibit the active taking, by whatever instrument, of net short positions in UK financial sector companies, defined as a UK bank or insurer, or a UK incorporated parent of a bank or insurer;
  • prohibit any increase of short positions in such companies held immediately before the rule came into force;
  • require any such pre-existing short position representing an economic interest of more than 0.25 percent to be disclosed on a daily basis for as long as it continues to be held.

The rules are currently set to remain in force until 16 January 2009, although the FSA has said that they will be reviewed after 30 days.

At the same time as it announced the new measures, the FSA also published answers to what they expect to be frequently asked questions about the new regime, together with a (now updated) list of the 34 UK financial sector companies that are covered by the prohibition [http://www.fsa.gov.uk/pubs/other/Shortselling_list.pdf]. The list is expressed to have been prepared on a “best endeavours basis.” Like the rules introduced in June 2008 requiring the disclosure of ‘significant’ short positions in traded shares when the issuer is undertaking a rights issue, the new measures have been introduced into the FSA’s Code of Market Conduct as evidential provisions. The new evidential provisions state that a person who enters into a transaction that has the effect of creating a net short position in a UK financial sector company or increasing a pre-existing short position is, in the opinion of the FSA, engaging in market abuse (misleading behaviour). Similarly, failure by a person who holds a pre-existing short position in such a company to disclose that position daily in accordance with the procedure set out in the Code is also, in the opinion of the FSA, misleading behaviour that constitutes market abuse. The potential penalties for failure to comply with the new provisions are the same as for any breach of the market abuse regime, and a fine or public censure.

Detail

The prohibition on short selling

The new measure effectively prohibits the active taking any of new short positions in UK financial sector companies, or the increase of existing short positions already held when the rules came into force on 19th September. It covers all short-selling instruments and all types of short positions, regardless of how they were obtained, and applies to “black box” trading. The prohibition on actively increasing pre-existing short positions is absolute: it is not permitted to increase the position intra-day, even if at the end of the day the position does not exceed that held and disclosed at the end of the previous day. However, if a short position arises other than by a person actively entering into a transaction, this does not breach the prohibition, although the disclosure rule may apply.

The only exemption from the prohibition is for market makers. The FSA has clarified that for this purpose “market maker” has a different meaning than the Handbook definition, and is intended to refer to an entity that ordinarily deals as principal in equities, options or derivatives to fulfil client orders or requests to trade or to hedge positions arising out of those dealings; or deals in order to provide liquidity to the market. An entity does not have to be registered as a “market maker” with an exchange or trading platform to fall within this exemption, but the activity must be genuine market making as described, and the FSA expects that short positions would be held only for a brief period.

The disclosure rule

The disclosure rule applies to any net short position which represents an economic interest of at least 0.25 percent of the issued capital of a UK financial sector company. A person holding such a position must disclose by means of a Regulatory Information Service using RIS short code SSD by no later than 3.30 p.m. on the business day following each day on which the short position is held. This obligation for ongoing daily disclosure differs from the one-off disclosure of significant short positions in companies undertaking a rights issue required by the rule that was introduced in June 2008, and remains in place.

Disclosure may be made by means of the TR4 Form available on the FSA website although use of the form is not compulsory. However, whatever format is used, it must include the full name of the person holding the position, the name of the relevant issuer, the size of the position as a percentage of the issued share capital, and the date that the 0.25 percent threshold was reached or exceeded.

To calculate the position for the purposes of disclosure, the holder may net its long and short positions in the company, and only an aggregate net short position of 0.25 percent or above will need to be disclosed. That disclosable net short position does not need to be broken down into its component parts.

Investment managers

Where an investment manager manages on a nondiscretionary basis, the prohibition and the disclosure obligation apply to the client. By contrast, if short positions are held for discretionary clients, the obligations apply to the fund manager, and the FSA’s FAQs specify in further detail how the obligations apply in relation to segregated, collective investment schemes and sub-funds of an umbrella fund.

Implications for firms

Firms will have to ensure that they have adequate procedures in place to monitor their short positions. Firms that use algorithmic trading will have to make any changes necessary to ensure that such trading complies with the new measures. This is likely to be particularly complex for firms that carry on proprietary trading and for non-discretionary investment managers. Proprietary trading positions are subject to the regime, and firms will be required to aggregate the positions in UK financial sector companies across all trading desks within the same legal entity. Similarly, for the purposes of calculating a disclosable short position, fund managers must aggregate the net short positions across all of the funds managed on a discretionary basis (although, in contrast, the prohibition applies at the level of each discretionary fund).

Restrictions in Other Jurisdictions

USA

The SEC also issued temporary emergency orders on 17th and 18th September which:

  • prohibit “naked” short selling of securities in any public company;
  • prohibit short selling of securities identified as those of a financial institution by national securities exchanges; and
  • require weekly filings by institutional money managers reporting short sales.

These orders were originally scheduled to expire on 1st or 2nd October, but on 1st October were extended until 11:59 ET on 17 October 2008.

EU

A number of EU Member States or their regulators have adopted similar measures prohibiting or restricting short selling. The measures adopted to date in Austria, Belgium, France, Greece, Hungary, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain and the UK are outlined in a document published by CESR on its website [http://www.cesr.eu/popup2.php?id=5238]. This document is being updated regularly.