MEPs limit naked short selling, scale back disclosure

The European Parliament's Economic Affairs Committee has agreed new measures that will severely restrict naked short selling activity in Europe, however it has dropped proposed public disclosure of short positions.
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The European Parliament's Economic Affairs Committee (ECON) has agreed new measures that will severely restrict naked short selling activity in Europe, however it has dropped proposed public disclosure of short positions.

ECON voted through an amended version of proposals made by the European Commission (EC) on 15 September 2010, dealing with short selling and credit default swaps, that must now be agreed by member states before becoming law.

According to the draft regulation, naked short positions must be covered or settled by the end of the trading day. A seller failing to make the conversion on time would incur fines that, the amended text states, “must be sufficiently high to prohibit any profits being made”.

The committee retains the ”locate and reserve rule', as set out in EC proposals, under which an investor had to have “borrowed the instruments concerned, entered into an agreement to borrow them, or have an arrangement with a third party who has located and reserved them so that that they are delivered by the settlement date”.

But the new draft only requires investment firms to report on their short sale transactions at the end of the trading day, rather than reporting each short sale as it happens, as proposed by the EC. Investors would also be required to publicly disclose less information than under original proposal.

Market participants must still notify regulators of net short-selling positions in selected stocks if a threshold of 0.2% or more is reached, but will no longer have to publish their net short-selling positions if they reach a threshold of 0.5% or more.

The Alternative Investment Management Association (AIMA), the hedge fund's industry association, had warned that these disclosure levels threatened efficient market operations. “There are serious unintended consequences of disclosing individual managers' positions to the market – including a decrease in liquidity, lower returns for end investors including retail investors, and the likelihood that investments will move to other jurisdictions where returns are not constrained by inappropriate regulations,” said Andrew Baker, CEO, AIMA.

Firms will be prohibited from being involved in credit default swap (CDS) transactions if they do not already own sovereign debt linked to that CDS, effectively naked CDS trading, or securities whose price depends heavily on the economic performance of the country, such as shares in a major company based there.

Short selling and credit default swaps were both raised as possible catalysts in Europe's recent sovereign debt crises by politicians and regulators. On 26 June 2010, the Group of 20 countries agreed to accelerate measures “to improve transparency and regulatory oversight of hedge funds, credit rating agencies and OTC derivatives in an internationally consistent and non-discriminatory way”.

If passed by the European Parliament, the rules would be applied permanently by national regulators and overseen by the European Securities and Markets Authority (ESMA) a body that enforces regulatory harmonisation across Europe. In addition to the disclosure rules, the proposal would give national regulators powers to temporarily restrict or ban short selling in any financial instrument, subject to coordination by ESMA in exceptional situations.

ESMA is also to be given the power to issue opinions to competent authorities when they intervene in exceptional situations and will have the option, when certain conditions are fulfilled, to adopt temporary measures, with direct effect, restricting or prohibiting short selling. In addition, if the price of a financial instrument falls by a significant amount in a day, national regulators will have the power to restrict short selling in that instrument until the end of the next trading day. Under the new, rules national supervisory authorities can require lenders to notify them in exceptional situations.

In emergencies, national authorities will be also required to provide more information within 24 hours to ESMA, when requested.

MEPs primarily involved with steering the regulation through Parliament will now negotiate a common text with member states which is then tabled for a plenary vote.

It had been hoped that the vote would take place at a plenary session on 5 April, with political agreement scheduled by the Council of the European Union in May, but this is dependent upon the negotiations. The regulation is then expected to be in force by 2012.