Questions Remain as EU Short-Selling Rules Enter Into Force

Terry Flanagan

The short-selling rules across Europe came into force on November 1, but market participants are unsure that the new regulation will actually achieve what they are meant to do—bring about a common regulatory approach across the region.

The European Securities and Markets Authority (Esma), the pan-European watchdog, wanted to bring disparate rules on short-selling across Europe under one regulatory roof from the start of this month but it appears that the rules in Spain and Greece—the two nations that currently have short-selling bans in place—will just be extensions of the present rules, which are slightly different in each jurisdiction, while the rest of the European Union will be subjected to Esma’s actual new technical standards, which are less onerous than the emergency bans imposed by Greece and Spain.

“We are basically back to square one as we are going to get a different rule in each country which is obviously not what Esma wanted as they wanted harmonization on this,” Mark Spanbroek, secretary-general of Brussels-based FIA European Principal Traders Association (FIA Epta), a proprietary trading group which represents firms that trade their own capital on European exchange-traded markets such as Knight Capital, Optiver, Getco, Citadel Securities and Quantlab Financial, told Markets Media.

“The local rules have just been extended. It is a very bad ruling. At the end of October, nations were meant to hand in their short-selling measures to Esma. But it appears that the rules in Spain and Greece are just extensions of the old measures.”

Short-selling bans in Europe were imposed by Spain, Italy, Belgium, Greece and France in August 2011 to help restore confidence to equity markets that were being weighed down by eurozone debt fears.

Greece and Spain, the two nations most embroiled in the eurozone crisis, both reinstated these bans earlier this year and have now re-submitted their templates to Esma asking the regulator to keep their bans in place even though each nation has a slightly different approach to implementing the short-selling bans.

In a statement, Esma said it was necessary to keep the Spanish and Greek bans in place as they constituted “a serious threat to financial stability and to market confidence” and were “appropriate and proportionate to address the above-mentioned threats” in both countries.

Due to different nations adopting their own separate short selling regimes in August last year, the European Union wanted harmonization of the process and thus agreed upon the new short-selling regulation in March, with Esma charged with writing the technical standards and enforcing the new rules.

Short selling is a process where you bet that shares will fall in price, by selling borrowed holdings and then buying them back cheaply. Under the new EU-wide rules, investors will have to disclose short positions and settle their short trade in four days, down from 30 days at present. The rules also cover certain aspects of sovereign credit default swaps and tighten rules on ‘naked’ short-selling, the process of selling shares that you have not already borrowed.

Esma put together the technical standards for issue on November 1 but had to recently conduct a consultation on exemptions for market makers and authorized primary dealers, with guidelines likely to be published this month. This lack of guidance on market making is causing some angst in the industry as market users are still not sure how the final rules will pan out.

The short-selling rules have provoked anger from many in the industry as they believe that it will put the brakes on securities lending activity and be harmful to liquidity in general, as well as hampering market making activities, which will in turn increase spreads.

Dr Christian Voigt, business solutions architect, Fidessa

Dr Christian Voigt, business solutions architect, Fidessa

“One of the reasons typically given for introducing a ban on short-selling is that such a move will combat volatility in the market,” Dr Christian Voigt, business solutions architect at trading and technology company Fidessa, told Markets Media.

“However, a number of studies have suggested that this assumption is flawed, and that a ban on short-selling is not a tried and tested method for stabilizing share and bond prices.

“Studies have also concluded that short-selling bans can be detrimental for liquidity especially for stocks with small capitalization and no listed options; it can slow price discovery, especially in bear markets, and fail to support prices.”

Market participants have also criticized the amount of time in which Esma was given to meet the strict deadlines imposed by the European Union on the new short-selling regime.

“It is difficult for Esma to consult with the industry and come up with a workable solution in the short time frame available,” said Kinetic Partners, a consultancy, in a note to clients.

Esma has a lot on its plate at present, as it is involved in drafting technical standards for an array of financial services regulations that are set to hit the industry in the coming months and years.

“It is frustrating as Esma has no budget available to cope with it all,” said Spanbroek at FIA Epta.

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