Regulators all over the world spent the latter part of September making emergency short selling rules. The UK was no exception. FSA’s new rules imposed a ban on taking short positions in some stocks and new disclosure rules. As with all rules made in haste, there were some unintended effects. FSA sought to address this by publishing three sets of FAQs.

What and where are the rules?

From 00.01am on 19 September FSA amended its Code of Market Conduct effectively to:

  • prohibit the creation or increase of net short positions in the shares of “UK financial sector companies”; and 
  • require the disclosure of net short positions in these shares of 0.25 per cent or more of the issued share capital of those companies.

Breach of these requirements would be regarded by FSA as market abuse.

What investments does it cover?

There is a definition of “UK financial sector company” and FSA has published a non-definitive list (which has changed over time) of companies that fall within it.

The ban covers positions that give rise to an exposure to a company’s equity share capital, irrespective of the financial instrument which creates the exposure. So the ban includes, for example, convertible bonds, derivatives and depository receipts.

Firms must also take into account any financial index made up entirely or predominantly of UK financial sector companies.

Are market makers exempt?

Trading undertaken genuinely in the capacity of market maker is exempt from the prohibition. Market makers must still comply with the disclosure rules.

FSA uses an expanded concept of market maker for this purpose. It includes firms that 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”. Within this it allows firms some flexibility.

How does this affect fund managers?

The prohibition does not apply in respect of a discretionary manager’s aggregated client positions (so the prohibition applies to the client). The disclosure requirements apply to both the client and the fund manager in respect of the aggregate position of its discretionary clients. For nondiscretionary management, both prohibition and disclosure apply to the client.

Are the rules permanent?

The rules will remain in force until at least January 2009, although FSA will review them after one month.

Where can I find out more?

We have produced two newsflashes to help our clients. One looks at the rules and FSA’s first set of FAQs. The other looks at FSA’s clarifications following specific concerns.

It’s not always easy to understand the way the rules apply to specific trading strategies.