Trade Bodies Highlight ‘Major Concerns’ With Esma’s Market Maker Exemptions

Terry Flanagan

It seems apt that the new short-selling rules in Europe kicked off the day after Halloween, as some market participants are fearful of the consequences that the far-reaching legislation will bring.

The rules, which entered into force on November 1, are intended to support the creation of a level playing field across Europe regarding the new short-selling rules, which were agreed upon by the European Union in March. Previously, national bodies had adopted their own disparate regimes.

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 even borrowed.

One of the major sticking points is over market making exemptions, which have still to be agreed upon by the European Securities and Markets Authority (Esma), the pan-European regulator, despite the new short-selling rules being in operation for nearly a week now.

It has left many in the market unprepared and confused. In mid-September, Esma issued an eleventh hour consultation on exemptions for market makers and primary dealers to the short-selling regulation with Esma not now expected to issue final guidance on what counts as market making until later this month.

The current Esma guidance on market making appears to suggest that legitimate market making activities, such as hedging using short selling practices to offset positions, may be prevented by the new short-selling rules. Some experts say that by disrupting market makers, who are willing to quote both bid and offer prices, it will lead to a reduction in liquidity and increase transaction costs for the end investor.

Markets Media has seen a letter, dated October 30, sent to Esma from the Association for Financial Markets in Europe (AFME) and the International Swaps and Derivatives Association (Isda), both trade bodies, highlighting “major concerns” about the approach taken by Esma to exemptions available for certain market making activities outlined in the proposed draft guidelines.

The letter urges Esma to permit hedging activities for market makers, clarify that a party does not need to be a member of a trading venue in order to be eligible for the market making exceptions and that market making exemptions must also be available for those instruments that are traded relatively infrequently.

In particular, the joint letter from AFME and Isda seeks clarity from Esma over firms managing their inventory in anticipation of a client order.

“Removing the possibility of hedging the risks associated with the acquisition of instruments in advance of client orders would be at odds with responsible risk management practices,” the letter said.

Others, too, believe that Esma is making a mistake over its market making exemptions.

“Market making is a vital function in the effective running of the markets,” said Eric Bommensath, head of corporate and investment banking at Barclays Capital, the investment banking arm of Barclays bank, in a letter to Esma last month.

“We believe the narrow interpretation of market making in Esma’s draft guidelines will have a detrimental effect on liquidity, competition, risk management and the ability of member states to access finance.

“Where firms are unable to act as market makers in certain instruments, liquidity will decrease and costs to execute will increase for the end investor.”

Then there is the Esma rule that is looking to certify those who wish to use either of the market making or primary market exemptions that they must notify their national regulator in writing that they intend to do so not less than 30 calendar days before they first plan to use the exemption.

“We believe that a notification period of 30 days with respect to the use of the exemption is far too long and not workable in practice,” said the Federation of European Securities Exchanges, which lobbies on behalf of 46 of the region’s exchanges, in a letter to Esma last month. “A period of 30 days represents an enormous extension in comparison to current business practice.”

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