On Tuesday 23 September, the United Kingdom (“UK”) Financial Services Authority (“FSA”) amended the provisions it introduced on Thursday 18 September to the Code of Market Conduct prohibiting short selling in UK financial sector stocks and imposing daily disclosure requirements with respect to short positions in such stocks (the “Short Sale Provisions”). Contemporaneous with this amendment, the FSA updated its Frequently Asked Questions (“FAQs”) to address questions and feedback it has received since the introduction of the Short Sale Provisions. By the amendment and the FAQs, the FSA has clarified the Short Sale Provisions with respect to (i) the definition of a ‘market maker’ exempt from the Short Sale Provisions; (ii) aggregation of positions across multiple trading desks of a single entity and across multiple investment funds managed by a single manager; (iii) short exposure to indices, baskets and exchange traded funds (“ETFs”); (iv) delta hedging with derivatives; and (v) transfer of short positions.
‘Market Maker’ Defined. The FAQs clarify that for purposes of the market maker exemption to the Short Sale Provisions, the term ‘market maker’ does not correspond to the definition of ‘market maker’ in the FSA’s Handbook, nor to an entity’s status as a registered ‘market maker’ with an exchange or trading platform. Instead, the FAQs make it clear that the market maker exemption only applies to entities that, in the ordinary course of their business, deal as principal in exchange traded or over-the-counter equities, options or derivatives to (i) fulfil orders from client requests (or to hedge positions arising out of such dealings) or (ii) provide regular liquidity to both the bid and offer sides of a market in comparable size. The FAQs indicate that the market maker exemption only covers individual transactions entered into by a market maker in its capacity as a ‘market maker.’ Although the FAQs indicate that the FSA will give ‘market makers’ some trading flexibility to allow them to anticipate sales, the FSA does not anticipate that market makers will hold significant short positions other than for brief periods of time.
Multiple Trading Desks and Multiple Funds. According to the FAQs, the short positions held by all of the trading desks in a single legal entity must be aggregated for purposes of the Short Sale Provisions. The FAQs also clarify that where a fund and its manager are separate legal entities, the short sale prohibition only applies at the level of the individual fund while the disclosure requirements apply at both the level of the individual fund and the fund’s manager. Thus, while either the fund manager or the fund itself must make the required disclosures on behalf of the fund, the fund manager must also disclose its aggregate short position across all of the funds it manages on a discretionary basis.
Basket of Shares, Share Indices and ETFs. The FAQs clarify that any economic interest in a UK financial sector company held as part of a basket, index or ETF must be aggregated with a market participant’s other short positions if the components of such basket, index or ETF are predominantly UK financial sector companies. The FAQs also indicate that market participants are not permitted to obtain a new or increased net short position in UK financial sector companies by shorting the basket, index or ETF (whether or not its components are predominantly UK financial sector components) and offsetting the components of the basket, index or ETF that are not UK financial sector companies with long positions.
Permitted Transfers. The FAQs make it clear that the transfer of a short position from one counterparty to another will not create or increase a net short position in violation of the short sale prohibition so long as the short position is transferred to the new counterparty with the same terms.
Derivative Trades. The FAQs clarify that derivative trades that are either delta neutral or delta positive at the time the orders are entered into are permitted. The FAQs note, however, that when rolling derivative positions expire, the delta position should not create a new overall net short position in a UK financial sector company.
The 23 September 2008 amendment to the Short Sale Provisions can be found on the FSA’s website at http://www.fsa.gov.uk/pubs/other/short_selling_instrument.pdf.