The Regulation of the European Parliament and of the Council of 14 March 2012 on short selling and certain aspects of credit default swaps (“the Regulation”) has already entered into force and will be fully applicable on 1 November 2012.
The Regulation intends to harmonise the different national regulatory regimes covering short selling of shares and sovereign debt in EU States by introducing:
- Ban on uncovered or “naked” short holdings in EU sovereign debt or listed shares;
- Ban on uncovered or “naked” long CDS holdings in EU sovereign debt;
- EU-wide disclosure regime to national regulators and markets for net short holdings in shares;
- EU-wide disclosure regime to national regulators for net short holdings in EU sovereign debt; and
- Competent Authority powers to impose temporary restrictions on the short selling of a financial instrument on trading venues in response to a considerable price fall.
We have completed the following FAQs in response to the most likely questions clients have posed to us.
Will market liquidity be reduced in shares and sovereign debt?
ESMA’s current guidance on the exemption for market making activities will likely have a damaging effect on the liquidity of EU equity and sovereign debt markets in the short term before and after the 1 November deadline. It is difficult for ESMA to consult with the industry and come up with a workable solution in the short time frame available. The FSA, which is responsible for the most liquid markets in many of these instruments, is bound by ESMA processes and cannot delay implementation. The first market maker notifications to the FSA are due to arrive on 2 November but the FSA will not know of the final notification arrangements until the last week of October.
In the long term, the liquidity of shares should not be materially reduced as the vast majority of hedge funds hold covered short positions in shares.
What is uncovered short selling?
Uncovered short selling is where the seller neither owns, borrows nor makes arrangements to borrow the security ahead of the sale.
What is the deadline?
The Regulation will come into effect on 1 November 2012. Net short holdings must be calculated as at midnight of each trading day. Where holdings require notification or disclosure these must be made no later than 3:30 pm local time of the following trading day. Therefore, the first notifications to the FSA will be due at 3.30pm (GMT ) 2 November 2012.
Who does this impact?
The Regulation defines the scope of the Regulation by listing the financial instrument to which the provisions of the Regulation apply.
For shares, the only decisive criterion is the admission of the instrument in question to trading on a trading venue in the Union (except where the principal trading venue of that instrument is in a third country), including when they are traded outside a trading venue in the Union.
For debt instruments, the main defining element is that these financial instruments are issued by a Member State or the Union.
Neither the domicile or establishment of the person entering into transaction on these financial instruments nor the place where these transactions take place, including third countries, are of any relevance in this regard. Therefore, managers based in New York or Hong Kong will be covered by the regulation as well as a manager based in London.
Which shares are covered?
ESMA already publishes a list of shares admitted to trading on an EU regulated market.
On 4 October 2012, a list of Exempted Shares where the Primary Trading Venue is not in the EU for the purpose of short selling regulation has been published on the ESMA website.
What debt is covered?
ESMA publishes on its website the net short position notification thresholds applicable for each sovereign issuer falling under the scope of the transparency requirements set out in the regulation. The publicly available list will identify the relevant Competent Authority for each of the sovereign issuers.
Which FSA rules will change?
The FSA has published its MarketWatch (Issue No. 42) Newsletter (‘MarketWatch’) setting out its approach to the transposition of this Regulation.
This Newsletter sets out the FSA’s intention to remove the existing short selling rules, currently under Chapter 2 of the FINMAR in the FSA Handbook, with effect from 1 November 2012. In its place will be the directly binding Regulations; however, the FSA will have all the powers necessary to enforce the Regulation, which it is required to do as a Competent Authority, including policies in relation to penalties.
What aggregated disclosures are required if we have more than one strategy?
This area requires detailed, tailored legal advice especially in global groups with sub advisory relationships. However, we believe the general principle is that net short holding calculations should be conducted firstly at the level of each individual fund or managed account to determine if they are net long or short in the instrument. The management entity would only aggregate the holdings of the funds or managed accounts which were net short in the instrument for aggregated disclosure purposes.
How will the notification be made?
The reporting channel will be specified by each Competent Authority on its website. ESMA will publish on its website the links to the relevant authority web page.
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