As we discussed in February, the Investment Industry Regulatory Organization of Canada released proposed amendments to the Universal Market Integrity Rules last month that would repeal the restrictions on the price at which a short sale may be made on Canadian markets.

As discussed in detail in our post of April 28, 2009, currently under UMIR, a short sale may not be made unless the price is at or above the last sale price for that security, subject to certain exceptions (referred to as the tick-test or the “uptick rule”) and there must be a “reasonable expectation” of settling the trade.

Under the proposed amendments, all price restrictions relating to short sales would be repealed and all short sales would be subject to the requirement to be “marked” as short sales, other than those exempt from marking as “short-marking exempt” orders. IIROC would have the ability to designate securities as being “short sale ineligible securities” and “pre-borrow” requirements would be imposed on certain securities (requiring that the person entering the order have made arrangement to borrow the securities that would be required to settle the trade prior to the entry of the order).

With respect to the proposed pre-borrow requirements, participants or access persons would be given specific direction as to circumstances under which they need to have made arrangements to borrow securities when entering a short sale. These would apply generally in circumstances where the security was previously subject to an “Extended Failed Trade.” An Extended Failed Trade is one in respect of which notice of the failed trade was required to be provided to IIROC in accordance with Rule 7.10 of UMIR as the reason for the failure had not been rectified within ten trading days following the date for settlement contemplated on the execution of the failed trade.

Orders from the following types of accounts for the purchase or sale of a security are proposed to be designated as “short-marking exempt” and would not be subject to the requirement to mark an order as “short”

  • an arbitrage account which makes a usual practice of buying and selling securities in different markets to take advantage of differences in prices;
  • the account of a person with Marketplace Trading Obligations in respect of a security for which that person has obligations; or
  • the account of an institutional customer for which order generation and entry is fully-automated, which, in the ordinary course, executes both purchases and sales of a particular security on one or more marketplaces on each trading day, and which, in the ordinary course, does not have at the end of each trading day more than a nominal position, whether short or long, in the particular security.

With respect to the changes in marking requirements, the intention is to allow IIROC to focus on monitoring short sale activity on accounts that have adopted a “directional” position with respect to particular securities. IIROC is also in the process of introducing an alert in its surveillance system that will be triggered when there is an increase in the level of short selling of an individual security (based on historic levels of short selling activity for that particular security) combined with a significant price decline in the market price of the security. According to the Notice, removing much of the “noise” in the short sale data flowing from trades by persons who are not taking a directional position should permit the alert to operate more effectively.

IIROC also released two studies it has conducted on the subject of short sales. The first, Price Movement and Short Sale Activity: The Case of the TSX Venture Exchange, considers the relationship between price movement and short sale activity on the TSX-V between May 1, 2007 and April 30, 2010. During this time, securities traded on the TSX-V were subject to price restrictions (the tick test) and the study finds that the price of securities traded fell further and faster than the price of TSX stocks, which were generally exempt from the tick test.

The second study, Trends in Trading Activity, Short Sales and Failed Trades, considers, as its name implies, the trends in trading activity of securities listed on Canadian marketplaces, specifically with respect to short sales and failed trends. Among its findings, the study states that securities that were exempt from the tick test did not decline in price as fast or as far during market stress periods as those that were subject to the test.

For more information, see IIROC Notices 11-0075, 11-0076, 11-0077 and 11-0078.