3 Financial services
| (31956)
13840/10
+ ADDs 1-2
| Draft Regulation on short selling and certain aspects of credit default swaps
|
| Legal base | Article 114 TFEU; co-decision; QMV
|
| Document originated | 15 September 2010
|
| Deposited in Parliament | 22 September 2010
|
| Department | HM Treasury
|
| Basis of consideration | EM of 22 September 2010
|
| Previous Committee Report | None
|
| Discussion in Council | Not yet known
|
| Committee's assessment | Politically important
|
| Committee's decision | Not cleared; further information requested
|
Background
3.1 The Commission held a four week public consultation on short
selling,[12] during June
and July 2010, following both the various restrictions on short
selling imposed by most Member States in the autumn of 2008 and
the concerns expressed by some governments about the possible
role played by credit default swaps in relation to the prices
for Greek sovereign bonds in the spring of 2010.[13]
The document
3.2 With this draft Regulation the Commission proposes introduction
of a number of permanent measures, as well as some temporary measures
to be employed in adverse circumstances, in relation to the short
selling of financial instruments.
3.3 The permanent measures the draft Regulation would
introduce are:
- a two-tiered disclosure regime
for equities, in line with the recommendations made by the Committee
of European Securities Regulators — persons (both natural
and legal) would be required to notify the relevant competent
authority if they had a net short position equal to 0.2% of the
value of the issued share capital of the company concerned and
each 0.1% above that, to disclose to the public details of their
net short position if it equalled 0.5% of the value of the issued
share capital of the company concerned and each 0.1% above that
and to disclose if the person's net short position were to fall
below each threshold;
- a private disclosure regime for significant net
short positions in sovereign debt — persons would be required
to notify the relevant competent authority of significant net
short positions relating to the issued sovereign debt of a Member
State or of the EU. As with the equities disclosure regime, a
threshold would be set at an initial amount and then incremental
amounts above that. A disclosure would also be made when the person's
net short position falls below each threshold. The Commission
would set the disclosure thresholds at a later stage by means
of a delegated act and they might be different for each Member
State;
- a similar private disclosure regime for 'naked'
(or 'uncovered') sovereign credit default swaps. A sovereign credit
default swap can be said to be 'naked' if the buyer of protection
does not own direct exposure to the underlying sovereign debt.
Naked credit default swaps are covered in the draft Regulation
because they are the economic equivalent of shorting a debt instrument;
- a requirement for competent authorities to summarise
the information they have gathered through the disclosure regime
and relay this to the European Securities and Markets Authority
on a quarterly basis — the authority would be able to request
additional information about net short positions relating to shares,
sovereign debt or naked credit default swaps from a competent
authority, which would be required to provide this within seven
calendar days;
- a requirement for persons trading on a trading
venue (a regulated market such as the London Stock Exchange or
a multilateral trading facility such as Chi-X Europe Ltd) to mark
their short sales on that venue — this would allow individual
trades to be identified as short sales. The trading venue is then
required to publish at least daily a summary of the volume of
orders marked as short orders;
- restrictions on the naked short selling of shares
and sovereign debt — one of three conditions would have
to be fulfilled: either the shares or sovereign debt instrument
are borrowed, the person has entered into an agreement to borrow
the shares or instrument or the person has an arrangement with
a third party under which that third party has confirmed that
the shares or instrument has been located and reserved for lending
so that settlement can be effected when it is due. The Commission
would further clarify the types of agreements or arrangements
meant;
- exemption from the proposed disclosure obligations,
the marking regime and the restrictions on naked short selling
for market makers, who use short selling to fill client orders
when the stock they need is not immediately available, and for
authorised primary dealers, who act similarly in the sovereign
debt market;
- a requirement for trading venues or central counterparty
clearing houses to introduce mandatory buy-in procedures and fines
for late settlement. Where the short seller were not able to deliver
the shares or sovereign debt instrument for settlement within
four working days after the day on which the trade took place,
or six trading days after the day on which the trade took place
in the case of market making activities, then, in order to ensure
delivery for settlement, the trading venue or clearing house would
have to buy-in the shares or instrument. If this were not possible,
then cash compensation would have to be paid to the buyer based
on the value of the shares or debt to be delivered at the date
due plus an amount for any losses incurred by the buyer. The short
seller who failed to settle would have to repay all the costs
incurred by the trading venue or clearing house and would have
the obligation to make daily payments (in effect, a fine) for
each day that the failure continued;
- an obligation for competent authorities to cooperate
with each other, including entering into agreements with competent
authorities in countries both inside and outside the EU to exchange
information and facilitate enforcement; and
- a role for the European Securities and Markets
Authority in coordinating investigation or inspection where that
concerned more than one Member State.
3.4 The transparency requirements would apply regardless
of where the person were located, including where the person were
located outside the EU, but had a significant net short position
in a company that had shares admitted to trading on a trading
venue in the EU or a net short position in sovereign debt issued
by a Member State or the EU. The disclosure regime would not apply
to short positions in companies where the principal venue for
trading their shares is outside the EU. The restrictions on naked
short selling and the buy-in procedures and fines for late settlement
would not apply to shares of a company admitted to trading on
a trading venue in the EU where the principal venue for the trading
of the shares were located in a third country. The European Securities
and Markets Authority would have to publish a list of such exempt
shares every two years.
3.5 The draft Regulation would give competent authorities
and the European Securities and Markets Authority power to introduce
a variety of temporary measures, where there were adverse developments.
The authority could take such action when the orderly functioning
and integrity of financial markets or the stability of whole of
part of the EU financial system was under threat. Competent authorities
could take action when there was a serious threat to financial
stability or to market confidence in the Member State or its neighbours
or in the EU.
3.6 In connection with temporary measures taken by
competent authorities the draft Regulation would introduce:
- the power, in defined adverse
situations, for a competent authority to introduce a disclosure
regime covering short positions in all financial instruments,
to prohibit or impose conditions on short selling and to prevent
persons from entering into transactions relating to financial
instruments or limiting the value of permissible transactions.
The competent authority would be free to set parameters, by applying
these restrictions to transactions in a specified share, or class
of shares, or in other specified circumstances, which are not
further defined, would be able to provide for exemptions in specified
cases and would be able to impose equivalent restrictions on credit
default swap transactions relating to sovereign debt;
- a requirement for the competent authority to
notify the European Securities and Markets Authority and other
competent authorities of its intention to take any of those measures
at least 24 hours before the action was to be taken, unless that
were simply not possible or in the case of an introduction of
a circuit-breaker — this would allow other competent authorities
to consider taking similar action;
- a requirement, within 24 hours of notification,
for the European Securities and Markets Authority to respond with
an opinion on whether the proposed or actual measure was necessary,
justified and of the correct duration and if it considered that
other competent authorities should take similar measures;
- a requirement for a competent authority, if it
proposed to take measures contrary to the European Securities
and Markets Authority opinion, to publish immediately on its website
a notice fully explaining its reasons for doing so;
- a provision allowing these temporary measures
to be imposed initially for a maximum three month period and to
be renewed for further periods not exceeding three months at a
time;
- the power for a competent authority to prohibit
short selling when the price of a share has fallen by 10% during
a trading day from the closing price the previous day. This would
apply to other financial instruments, with the Commission specifying
in a delegated act the appropriate fall in value for financial
instruments other than shares. Such a restriction, or 'circuit-breaker'
would be temporary and apply for a period not exceeding the day
after the price fall; and
- a requirement for the competent authority to
publish on its website notice of any decision to impose or renew
any temporary measure, outlining the reasons for the actions taken
and the evidence to support it.
3.7 In connection with temporary measures taken by
the European Securities and Markets Authority the draft Regulation
would introduce:
- the ability of the authority
to place temporary restrictions directly on both natural and legal
persons when the activities carried out threaten the orderly functioning
and integrity of financial markets or the stability of the whole
or part of the financial system and it was not satisfied that
the competent authority or Authorities had taken adequate measures
to address the threat. In such situations the European Securities
and Markets Authority could prohibit persons from trading or limit
the value of such trading, prohibit persons from entering into
short sales or impose conditions on such sales, prohibit sovereign
credit default swaps transactions, limit the value of naked sovereign
credit default swaps and require public disclosure of short selling;
- a requirement for the European Securities and
Markets Authority to give competent authorities 24 hours notice
of any such temporary restriction (unless, in exceptional circumstances,
this were not possible);
- requirements for the European Securities and
Markets Authority, where appropriate, to consult with competent
authorities and the European Systemic Risk Board before taking
its decision and to review its decision at appropriate intervals
and at least every three months after which, if it were not renewed,
it would end;
- the ability for the European Securities and Markets
Authority to override any measures taken by a Member State, or
to impose measures if the Member State had not deemed it necessary
but ESMA considered such measures necessary to address a threat
to the orderly functioning and integrity of financial markets
or the stability of the whole or part of the financial system;
- a requirement for the Commission to provide further
clarity on the definition of such adverse events, developments
and threats to the orderly functioning and integrity of the financial
markets;
- the ability of the European Securities and Markets
Authority to conduct an inquiry into a particular issue or practice
relating to short selling or credit default swaps to assess whether
any threat was being posed by them; and
- a requirement for the European Securities and
Markets Authority to publish the findings of any such inquiry.
3.8 The proposed Regulation would be directly applicable
in all Member States, is expected to apply from 1 July 2012 and
would be reviewed by 30 June 2014.
The Government's view
3.9 The Financial Secretary to the Treasury (Mr Mark
Hoban) tells us, in relation to the EU Charter of Fundamental
Rights, that:
- the requirement in the draft
Regulation that information in relation to net short positions
held by a person should be publicly disclosed might give rise
to issues in relation to Article 7 (respect for private and family
life) of the Charter if the information concerned is personal
information — this would not usually apply (in most cases
a person holding a short position would not be trading on their
own account) and where it did the requirement for disclosure would
be likely to be justified; and
- the exercise of powers given to competent authorities
and to the European Securities and Markets Authority in the proposed
Regulation to prevent persons from entering into certain transactions
might in some circumstances raise issues under Article 17 (right
to property) of the Charter.
3.10 On the policy implications of the proposal the
Minister first says that:
- as the Commission acknowledges,
most studies conclude that short selling contributes to the efficiency
of markets, increasing market liquidity and leading to the more
efficient pricing of securities and ultimately a better deal for
investors;
- the Commission also acknowledges that short selling
is an important tool that is used for hedging and other risk management
activities and market making; and
- the Government supports these views.
3.11 The Minister then comments that:
- the Government agrees that
it is important that all Member States have clear and unequivocal
powers to take action against short selling in adverse circumstances;
- the UK introduced a temporary short selling prohibition
in the autumn of 2008 at a time of extreme market turbulence —
this temporary prohibition naturally expired in January 2009 when
the market conditions prevalent had ceased, principally when the
sharp share price declines in individual banks that led to pressure
on their funding had normalised;
- the Financial Services Authority maintains a
disclosure regime in relation to short positions in stocks in
UK financial sector companies as a proportionate response to any
outstanding or future risk short selling may present;
- short selling which is carried out in connection
with abusive strategies (such as the spreading of false rumours
in order to drive down prices) is already prohibited by the Market
Abuse Directive;
- the Financial Services Act 2010 gives the Financial
Services Authority clear powers to take action against short selling
and to impose a disclosure regime on equities;
- therefore, the Government welcomes the Commission's
proposals towards enhanced transparency requirements for equities
and is supportive of the two tier disclosure regime — these
proposals are in line with those of the Committee of European
Securities Regulators, which the Financial Services Authority
attends on behalf of the UK;
- the Government believes any further proposals
imposing restrictions or measures on short selling should be both
evidence based and proportionate;
- it is aware that no evidence has yet been presented
to support a disclosure regime in sovereign bonds, or to support
restrictions on credit default swaps;
- naked sovereign credit default swaps can be used
for a variety of different purposes other than insurance against
actual sovereign default, such as managing the general credit
exposure from that country;
- the proposed disclosure measures and restrictions
on naked short selling relating to sovereign debt have the potential
for a negative impact on sovereign bond markets across the EU
and ultimately on a sovereign's cost of borrowing;
- the Government notes that these proposals give
the European Securities and Markets Authority powers to intervene
in UK markets, including over the UK gilt market, and believes
that the power to intervene in these markets should rest with
Member States due to the fiscal impact of interventions in sovereign
debt markets;
- the proposal implies significant and unmet ongoing
costs for both firms and individuals, trading venues and clearing
houses in establishing the infrastructure necessary to meet its
requirements; and
- the Government does not support proposed restrictions
on short selling that are not evidence based and have little in
the way of quantifiable benefit.
3.12 Turning to the financial implications of the
draft Regulation the Minister says that the Commission's Impact
Assessment identifies the risks, and therefore the costs, of short
selling during adverse developments:
- the risk of negative price
spirals;
- the risk of settlement failure associated with
naked short selling;
- transparency deficiencies; and
- regulatory arbitrage and increased compliance
costs.
In the Impact Assessment the Commission argues that
these risks are likely to occur again in the future without the
proposed Regulation and that uncoordinated national measures are
more costly to market participants. The cost of these risks has
not been quantified.
3.13 On the Commission's estimates of the costs of
the proposed Regulation the Minister says that:
- the EU-wide one-off compliance
cost related to the notification and disclosure requirements of
equities is approximately €137 million (£113 million);
- annual ongoing costs are estimated to be 10%
of this cost, or approximately €13.70 million (£11.30
million);
- these costs represent investment in information
technology and information systems, training and compliance procedures;
- the ongoing annual cost of disclosure to the
regulator and to the public when the relevant equities threshold
is exceeded is estimated to be approximately €2.10 million
(£1.73 million) — therefore, the annual EU-wide compliance
cost of an equities disclosure regime (not including the one-off
cost) is approximately €15.80 million (£13 million);
- the one-off costs for the sovereign bond disclosure
requirement is estimated to be in the order of €34.20 million
(£28.20 million), with an annual cost of €3.40 million
(£2.80 million) and, when the thresholds are exceeded, a
further €1.60 million (£1.30 million) — therefore,
the annual EU-wide compliance cost of a sovereign bond disclosure
regime (not including the one-off cost) is in the order of €5
million (£4.10 million);
- the administrative cost on regulators of quarterly
reporting to European Securities and Markets Authority of significant
net short positions in their jurisdictions, based on two hours
work by a manager, is estimated to be a total annual EU-wide cost
to regulators of €6,758 (£5,574); and
- this cost does not include the cost of establishing
a marking regime, because no cost estimates other than from the
UK have been received — the Financial Services Regime has
previously estimated that the cost to individual broking firms
of establishing a marking regime would vary from several hundreds
of thousand pounds to around £2 million.
3.14 On consultation the Minister says that key industry
stakeholders are aware of the proposal and that the Treasury arranged
a stakeholder group ahead of the first Council working group meeting.
Conclusion
3.15 It is clear that the Government has, with
good reason, considerable reservations about this draft Regulation.
We share these reservations. However before considering the document
further, which we are likely in due course to recommend for debate,
we should like to hear from the Government about:
- discussion of the draft
Regulation in the Council working group, particularly in relation
to the Charter of Fundamental Rights, to the potential for fiscal
consequences of European Securities and Markets Authority market
interventions, to the lack of an evidence base for the proposal
and to the unquantified cost of the risks being addressed; and
- representations made to the Government by
UK stakeholders.
Meanwhile the document remains under scrutiny.
12 The practice of selling assets that have been borrowed
from a third party with the intention of buying identical assets
back at a later date to return to the lender and with the hope
of profiting from a decline in the price of the assets between
the sale and the repurchase. Back
13
A sovereign credit default swap is a contract in which one party
pays a fee to another party in return for compensation or payment
in the event of the sovereign experiencing a specified credit
event (such as where a sovereign repudiates or declares a moratorium
on paying its debt). Back
|
