EU: ESMA's recommendations on changes to the Short Selling Regulation

ESMA has published its Technical Advice on the evaluation of the EU Short Selling Regulation ("SSR" - Regulation 236/2012 of the European Parliament and of the Council on short selling and certain aspects of credit default swaps) came into force on 1 November 2012, and has recommended that the European Commission consider making several adjustments to the SSR.     

The SSR requires the European Commission to report to the European Parliament and the Council by 30 June 2013 on the appropriateness, impact and operation of the SSR, and to discuss these issues with competent authorities and ESMA before doing so.  The Commission therefore formally mandated ESMA to provide Technical Advice on the evaluation of the Regulation by 31 May 2013.  ESMA conducted a quantitative analysis, a public consultation in the form of a Call for Evidence and a survey among national competent authorities to assist in its review.

Although the available data is limited, ESMA concludes overall that there have been some positive effects in terms of enhanced market transparency and improved settlement discipline.  The effects on the liquidity of EU stocks have been mixed, with a slight decline in volatility, a decrease in bid-ask spreads, no significant impact on traded volumes and a decrease in speed of price discovery.  In respect of CDS, there has been an impact on the liquidity of EU single name CDS (and on the related sovereign bond markets) in isolated countries, though not overall - and no individual Member State has exercised its right to lift the restrictions in the event of a serious effect on the liquidity of their sovereign debt markets temporarily - but the liquidity in European sovereign CDS indices has reduced.

The Technical Advice acknowledges that its findings should be interpreted with caution in view of the difficulties in identifying the specific effects of the SSR and of the limited time period for the assessment.  ESMA therefore suggests that the European Commission should revisit the assessment of the SSR at a later stage.

Specific recommendations:

Transparency and reporting requirements:

• Shares:
  • no change to current reporting and disclosure thresholds
  • some technical improvements
    • to facilitate the access by investors to information on indices and on issued share capital
    • in the information to be notified in respect of net shorts net shorts where backed by long positions:
      • in actively managed funds
      • in convertible bonds or subscription rights
    • clarification of the treatment of contracts with similar/symmetrical effects such as stock lending, collateral and pledges contracts
• CDS:
  • revisiting the method of calculation of net short positions in sovereign debt;
    • the duration-adjusted approach is less useful in times of market stress than the nominal method
    • if the duration adjusted method is retained, then it should be used (with appropriate adjustments) for positions in derivatives as well as for cash positions
  • reviewing the thresholds for notification
  • moving to an annual review
  • publicising the list of public entities whose debt is included in the calculation of the issues sovereign debt

Restrictions on uncovered short sales in shares and sovereign debt: 

• allowing internal locate arrangements within the same legal entity
  • requirement for ring-fencing of internal lending desk activities from trading desk
• reviewing the definition of "liquid shares" for the purpose of locate arrangements once proper regulatory data on securities lending is available.

Settlement discipline including buy-in procedures

• settlement discipline requirements, notably the buy-in procedures, are better/more extensively dealt with in forthcoming CSD Regulation
  • ensuring a level playing field in the application of the buy-in and settlement penalties procedures
  • catering for the particular case of illiquid shares and SMEs shares

Ban on uncovered Sovereign CDS transactions:

• improving legal certainty by clarifying definitions
  • the quantitative and qualitative correlation tests are to be applied separately, not in combination
• various refinements including
  • use of sovereign CDS indices for hedging
  • cross-border hedging under certain liquidity conditions and correlation circumstances (where the sovereign CDS market is non-existent or very illiquid)
  • group hedging through a dedicated entity
  • clarification on whether sovereign CDS positions entered into pre-SRR can be novated without infringing the prohibition
    • if such contracts are 'grandfathered', the duration and amount of the con-tract should not be extended

Exemptions for shares on the basis of turnover calculations

• an amended negative-list approach essentially based on two criteria:
  • the domicile of the issuer
  • if admission to the European venue has been requested by that issuer

Exemptions for market-making activities:

• further changes and clarifications, particularly
  • scope of, and conditions of use for, the exemption
    • particularly the requirement for membership of a trading venue - extending the exemption to market making activities on purely OTC traded instruments
    • expanding the scope of financial instruments eligible for exemption
  • a change to the instrument by instrument approach for the purpose of notifications
    •  possible exemptions on the basis of particular exchange indices
  • disapplication of the 30 day period for objecting to use of the exemption in respect of newly admitted instruments where market maker specifically mandated by trading venue to undertake market making

Emergency measures in the case of a significant price fall

The data on the interventions to date makes for particularly interesting reading.  However, no clear conclusion could be drawn as to the effectiveness of the few short-term bans imposed (by Consob) in case of a significant fall in price of a financial instrument; longer term bans appear to have mixed impacts.

ESMA proposes:

• further action to improve communication and publication of bans (but only as a level 3 measure)
• simplification of the approach for introduction of temporary bans
  • allowing the competent authority of the most relevant market in terms of liquidity to exercise its judgment without the need of a threshold mechanism
  • other concerned competent authorities should follow the measure
• Change of thresholds set to identify significant price fall
  • threshold for corporate bonds and sovereign bonds is currently set too low
  • no thresholds are required for listed UCITS (other than ETFs) or for commodity derivatives