On 15 September 2010, the European Commission (“Commission”) published its proposal (the “Proposal”) for a pan-European short selling regime1, which also takes into account uncovered credit default swaps (which have an equivalent economic effect). The regime, if implemented, would require greatly increased disclosure, both to the regulator of the relevant EU country and to the markets generally. It is also proposed that EU regulators be given powers to ban short selling more widely at times of threat to financial stability or to market confidence in the EU. It is expected that once the Proposal is negotiated and adopted by EU lawmakers, the new regime would come into force on 1 July 2012.
In July 2009, the Committee of European Securities Regulators (“CESR”) published a consultation on a pan-European short selling regime2. It was followed on 2 March 2010 by a report outlining CESR’s proposed model regime (the “Report”)3 for a two-tier model for the disclosure of significant individual net short positions in all shares that are admitted to trading on a European Economic Area (“EEA”)-regulated market and/or an EEA multilateral trading facility, when the primary market of those shares is located in the EEA:
- A private disclosure to the relevant regulator of any net short position in a company's issued share capital that reaches a threshold of 0.2%. Any increases or decreases of 0.1% above the 0.2% threshold would trigger further disclosure obligations, meaning that, for example, notifications would need to be made to the relevant regulator at 0.3% and 0.4% and so on; and
- A public disclosure to the market as a whole as well as to the relevant regulator once the short seller's net short position reaches 0.5%, and at every 0.1% above that (for both increases and decreases).
Since the Report:
- Germany’s Federal Financial Supervisory Authority, Bundesanstalt für Finanzdienstleistungsaufsicht ("BaFin"), has implemented a variation on the proposals requiring market participants and holders of net short positions in any of 10 selected financial stocks (primarily banks) to make disclosure to BaFin when the net short position reaches, exceeds or falls below a threshold of 0.2% of the issued share capital of that company and every 0.1% thereafter. BaFin also announced that it will publish (in an anonymous format) all short positions that reach or exceed 0.5%.
- The UK’s financial regulator, the Financial Services Authority (“FSA”), published its revised and recast short selling rules on 23 July 2010. These rules require a public disclosure to the market as a whole as well as disclosure to the FSA of:
- Net short positions of 0.25% or more in companies undertaking rights issues (and whose shares are admitted to trading on a UK prescribed market), with a further disclosure required when the net short position falls below 0.25%; and/or
- Net short positions in UK financial sector companies in excess of 0.25% of ordinary share capital. Additional disclosures are required if the short position reaches, exceeds or falls below 0.25%, and each 0.1% thereafter, of the share capital of the company (i.e., disclosures required at thresholds of 0.25%, 0.35%, 0.45%, etc.). Where a net short position decreases below the 0.25% threshold, a final disclosure must be made.
In both cases, the FSA requires that the disclosure should include the name of the person who has the disclosable short position, the amount of the disclosable short position and the name of the company in relation to which the person has the position. For more information on the revised and recast UK short selling rules, please refer to our 5 August 2010 Client Alert4.
The Commission followed up on CESR’s Report with its own consultation on 14 June 20105. The Proposal is the Commission’s response to this consultation and sets out a draft EU regulation to provide for the maximum harmonisation of short-selling rules across the EU to avoid regulatory fragmentation and the risk of regulatory arbitrage. The harmonisation of short selling disclosures will create a level playing field across the EU with the same types of disclosure (i.e., private disclosure to the regulator or public disclosure to the market) at the same disclosure thresholds.
Proposed EU Short-Selling Rules
The key provisions of the Proposal are:
Instruments covered by the rules: The Proposal covers shares6 and other financial instruments admitted to trading on an EU market7 (“Relevant Financial Instruments”), derivatives relating to such EU-listed financial instruments (even when traded outside a trading venue), EU sovereign bonds and derivatives relating to EU sovereign bonds, and credit default swaps (“CDSs”) relating to EU sovereign issuers. The Proposal provides for a proportionate response to the risks that short selling of different instruments may represent. CDSs are covered, since buying CDSs without having a long position in underlying sovereign debt can be considered to be, economically speaking, equivalent to taking a short position on the underlying debt instrument.
Disclosure of net short positions: The Proposal applies transparency (i.e., disclosure) requirements to persons with significant net short positions8 relating to Relevant Financial Instruments and to persons with significant CDS positions relating to EU sovereign debt issuers as follows:
- For companies that have shares admitted to trading on a trading venue in the EU, it provides for a two-tier model for transparency of significant net short positions in Relevant Financial Instruments:
- At a threshold of 0.2% (of the value of the issued share capital of the company concerned) and each 0.1% above that (up to 0.4%), notification must be made privately to the regulator;
- At 0.5% and each 0.1% above that, notification must be made both to the regulator and publicly to the market (with such notification to include details of the identity of the person who has the relevant position, the size of the relevant position, the issuer in relation to which the relevant position is held and the date on which the relevant position was created, changed or ceased to be held).
- For significant CDS positions relating to EU sovereign debt issuers, private disclosure to regulators will also be required, although the threshold level has not yet been set.
Territorial effect: The Proposal and the disclosure rules would apply to any person anywhere in the world who has a net short position in Relevant Financial Instruments traded on an EU trading venue or who effectively shorts EU sovereign bonds by using CDSs.
Content of disclosures: The relevant disclosures must cover, at a minimum, the identity of the person who has the relevant disclosable net short position, the size of the position, the issuer in relation to which the position is held, and the date on which the position was created, changed or ceased to be held9.
Timing of disclosure: Disclosure must be made by not later than 3.30 pm (local time in the relevant market) on the next trading day after which the person first has the disclosable position or passes through the relevant 0.1% incremental threshold(s).
Method of notification: The notification of information to a relevant competent authority would need to be made in accordance with the relevant electronic notification systems in place in each EU country (as currently used for the notifications of substantial disclosable shareholdings in listed companies).
Penalties for failure to notify regulator: The Proposal gives EU regulators all the powers necessary for the enforcement of the rules – including access to documents, the right to obtain information from persons and to take enforcement action against them or impose fines for breach of the relevant rules (the level of fines has not yet been determined).
Prohibition of naked shorts and proposed EU ”locate” rule: Persons entering into short sales of Relevant Financial Instruments or CDS positions relating to EU sovereign debt issuers must at the time of the sale have borrowed the instruments, entered into an agreement to borrow the instruments or made other arrangements which ensure that they can be borrowed so that settlement can be effected when it is due. The requirement permits legitimate arrangements that are currently used to enter into covered short selling and which ensure that securities will be available for settlement10.
Buy-in requirement: In support of the prohibition on naked shorts, trading venues will be required to implement rules to ensure that if a person fails to deliver the Relevant Financial Instruments or sovereign debt instruments within four days after the day on which the relevant trade takes place, the trading venue or the central counterparty that provides clearing services for the trading venue must buy-in the instruments for settlement and, if they cannot be bought, that cash compensation must be paid to the buyer by the trading venue or the central counterparty based on the value of the instrument(s) to be delivered at the delivery date plus an amount for any losses incurred by the buyer. Any person who fails to settle a transaction must be banned from entering into any further short sales of Relevant Financial Instruments or CDS positions relating to EU sovereign debt issuers for as long as the transaction remains unsettled.
Flagging short orders: EU trading venues will also be required to establish procedures to ensure that persons executing orders on the trading venue mark sell orders as short orders where the seller is entering into a short sale. The trading venue will also be required to publish a daily summary of the volume of orders marked as short orders.
New powers for EU regulators: The Proposal recognises that in “exceptional situations” it may be necessary for EU regulators to prohibit or restrict short selling activities that would otherwise be legitimate or pose minimal risks. The Proposal provides that in the case of “adverse developments which constitute a serious threat to financial stability or to market confidence in the EU”, regulators should have temporary powers to require further transparency or to impose restrictions on short selling and credit default swap transactions or entering into derivative transactions. The power of intervention for regulators only contemplates temporary action/ bans for up to three months — with extensions of up to three months at a time, but this must be fully justified as well as being notified to and confirmed by the new European Securities and Markets Authority (“ESMA”)11. ESMA may itself take action and impose a pan-European ban where two conditions are fulfilled: (1) there is a threat to the orderly functioning and integrity of financial markets or the stability of the whole or part of the financial system in the EU (and there are cross-border implications); and (2) measures have not been taken by competent authorities, or are not sufficient, to address the threat.
The EU regulation set out in the Proposal will now be debated by the European Parliament and the European Council of Ministers. It is generally anticipated that agreement will be reached within a relatively short time frame, although the Proposal states that the relevant short selling regulation would become law on 1 July 2012.