The recent “short squeeze” involving video game retailer GameStop rocked securities trading in late January, causing the price of GameStop shares to surge by 1745%. The precise reason for this surge has already been the subject of a US Congressional hearing and all manner of explanations have been put forward by commentators including COVID-19 induced boredom and conspiring bots. While it seems likely that the story will ultimately result in legislative changes in the US, it may also have implications for EU financial services legislation.
Specifically, on 17 February, ESMA published a statement warning retail investors of risks associated with trading when a stock is higly volatile (here). A few days later, on 23 February, Steven Maijoor, the Chair of ESMA, and Ugo Bassi, the European Commission’s Director for Financial Markets indicated that the events around GameStop could also impact on EU financial services regulation, while acknowledging that “the likelihood of similar events happening in the European Union appears limited”.
Specifically, when speaking at an exchange of views with the European Parliament’s ECON Committee on “GameStop Share Trading and related phenomena”, Mr Maijoor and Mr Bassi indicated that it may be necessary to take a closer look at the phenomenon of zero commission trading and the market abuse regime. They also discussed the rules on securities lending and short-selling, and the importance of financial education.
Zero Commission Trading
Recent years have seen online brokerages offer zero commission trades on securities and other financial instruments. Some brokers have substituted for the loss of those commissions through receiving payments for order flow (“PFOF”) from third parties, such as market makers. According to Mr Maijoor, PFOF needs to be carefully assessed against the MiFID II requirements on conflict of interest, best execution and inducements. Mr Maijoor also commented that PFOF may be difficult to reconcile with the requirement to put the client first. ESMA and the Commission are already in contact on this issue and are considering whether the MiFID rules are sufficient to prohibit all types of PFOF schemes.
According to Mr Maijoor, in addition to zero commission trading, other practices also deserve scrutiny, such as the use of investment apps combined with the “gamification of investing”, which involves the application of typical elements of game playing to other activities, including investment activities. This could include, for example, sending daily push notifications or displaying confetti raining down after each trade, in an effort to encourage customers into consistent participation and long-term engagement with the relevant trading platform.
Market Abuse Regime
Market manipulation essentially involves behaviour giving false or misleading signals as to the supply, demand or price of a financial instrument or likely to secure its price at an abnormal or artificial level. Generally, statements regarding an intention to buy or sell a stock on a social media platform do not necessarily constitute market manipulation. However, as Mr Maijoor indicated, they may do so if they are part of a coordinated strategy to buy and sell at certain conditions and at a certain point in time with the objective to inflate the share’s price. Moreover, posting false or misleading information about an issuer of a financial instrument on social media may represent market manipulation.
While Mr Maijoor considered that the market abuse framework remains fit for purpose, he suggested that it may be necessary to look at the behaviour of licensed financial intermediaries on social media and to clarify the applicable rules for such intermediaries when engaging in on-line chat boards. He also observed that once there is an identified risk of possible market abuse on the part of retail investors, privacy issues may pose a potential barrier to investigating this.
In the EU, short-selling is regulated pursuant to the Short Selling Regulation 236/2012, which imposes restrictions on the short-selling of certain EU equity financial instruments and sovereign debt, and requires investors to disclose to the relevant regulator any net short positions in EU sovereign debt and equities traded on EU trading venues.
According to Mr Bassi, the European Commission will reflect on whether amendments need to be made to the Short Selling Regulation such as reducing the thresholds for the disclosure of positions and/or imposing disclosure not only towards regulators but publicly in order to reduce information asymmetry between regulators and the public. However, Mr Bassi also stated that before adopting any such measures, the European Commission would undertake a rigorous assessment of their pros and cons.
Currently, under the EU’s Securities Financing Transactions (“SFTs”) Regulation 2015/2365, counterparties are obliged to report the details of all SFTs to a Trade Repository, which must publish aggregate positions by type of SFT reported. Mr Bassi suggested that it may be necessary to consider whether these rules should be reinforced or if there is a need to introduce more transparency to make those using securities lending more accountable.
It is clear from the ECON Exchange of Views that the events around GameStop have captured the attention of both ESMA and the EU Commission, which are assessing its implications both from an investor protection perspective and as regards the orderly functioning of financial markets.
Significantly, however, there is no suggestion on the part of either Mr Maijoor or Mr Bassi that those events should lead to restrictions on the ability of retail investors to invest in financial instruments, or the use of financial investment apps. On the contrary, both view the active participation of retail investors in financial markets as being a key part of the EU’s Capital Markets Union. The concern is rather that events such as GameStop could cause retail investors to lose their trust and confidence in financial markets inhibiting both their own willingness to invest and their faith in the financial system.
As such, GameStop is likely to have significant implications for the European Commission’s forthcoming retail investor action strategy, which is expected to be published in the first half of 2022. One of the key aims of the strategy is to make the EU an “even safer place for individuals to save and invest long-term” and the events around GameStop shares will clearly need to be carefully analysed in this regard. However, there is only so much that can be achieved by legislation and ultimately financial education may have a more important role to play in improved investor protection than a series of legislative reforms.