Commission plans to take on short-selling
The European Commission today (15 September) proposed to regulate the short-selling of financial instruments, warning that, if left untouched, the practice posed a threat to financial stability.
Michel Barnier, the European commissioner for the internal market, said that he wanted to eliminate “abusive” use of short-selling by traders that brought them quick profits but led to damaging shocks on the financial markets.
“Today’s proposals are a further step towards financial stability in Europe,” Barnier said.
Short-selling is where traders sell a financial product, such as shares or bonds, that they do not own in the expectation that they will be able to buy the product at a lower price later on. It is a way of making a profit from a falling market.
The draft regulation proposed by the Commission would oblige traders that short-sell large amounts of shares or government bonds to disclose their positions to regulators and, in the case of shares, to the market. The draft would also oblige traders to make firm arrangements, prior to sale, to obtain the financial instrument they intend to short-sell.
Barnier is also keen to avoid any repeat of events in May when Germany shocked other member states, and the markets, by banning so-called ‘naked’ short- selling of certain financial instruments. The timing of Germany’s decision was sharply criticised by other governments, as it increased market uncertainty at the height of the eurozone debt crisis.
Naked short-selling is when a trader arranges a sale without ensuring in advance that the security can be borrowed.
The Commission’s proposal sets out a list of conditions that must be met before a national regulator can ban short-selling of a particular financial instrument, to ensure that bans are only introduced in emergency situations.
Andrew Baker, chief executive of the Alternative Investment Management Association, which represents the hedge-funds industry, said: “One of the major problems that the industry has faced in respect of short-selling regulation was that some EU jurisdictions acted unilaterally and arbitrarily in imposing and then lifting bans.”
“A common regime that concentrates on reporting rather than bans is the way forward,” he added.
The International Swaps and Derivatives Association, which represents banks and non-financial firms with large derivatives operations, said that it supported “steps taken in the proposals to increase transparency to regulators and safeguards to ensure any proposed measures take account of the need to preserve market liquidity”.
Jean-Paul Gauzès, the Parliament’s lead MEP on legislation to regulate hedge funds and private equity, said: “These proposals lay the foundations…to draw the consequences on the financial crisis and set up a system to prevent other crises.”
The Commission intends to further refine the conditions that must be met for a ban to be introduced.
Its proposal would also require a regulator to give at least 24 hours’ notice to the European Securities and Markets Authority (ESMA), an EU-level supervisor, before introducing a ban (although this time-limit could be shortened in exceptional situations). ESMA would rapidly inform regulators whether the ban was justified.
An element of the proposal that is likely to prove controversial for governments is that ESMA could, on its own initiative, ban short-selling throughout the EU, if it felt that national regulators had failed to act to deal with a crisis.
The Commission proposal covers short-selling of shares and sovereign debt, and also trading in credit-default swaps (CDS), a type of financial instrument that insures the holder against default or loss on another asset. Some types of CDS trading have been likened to short-selling, because the trader is betting on a company or government being unable to honour its obligations.
The Commission made a separate proposal today to regulate the market for derivatives, a class of financial instrument (including credit-default swaps) whose value is expressly linked to other market movements.
The Commission proposed that trading in common forms of derivatives should pass through clearing houses, which sit in the middle of trades and impose safeguards so that each party can meet its obligations. It also proposed that trades should be logged in ‘repositories’ – essentially large databases. Barnier said that the measures would improve market stability and transparency.