Short Selling Regulation (SSR)

Background

As a result of the severe volatility experienced in 2008 during the financial crisis, several EU countries attempted to restore the functioning of global markets by introducing bans on short selling activity. This divergent and uncoordinated approach however caused multiple compliance difficulties and opportunities for arbitrage.

As a result and in March 2012 therefore, the European Commission published the regulation to establish a harmonised framework that regulates the entry and disclosure of short positions.

Overview

EU Regulation 236/2012 on short selling and certain aspects of credit default swaps entered into force in November 2012. SSR aims to provide greater transparency of short positions held by investors in EU securities, reduce or eliminate settlement risks associated with uncovered or naked short positions, and give Member States clear powers to intervene in exceptional situations, to reduce systemic and market risks.

What is Short Selling?

There are two types of short selling activity, covered and naked shorting. Short selling is when an investor sells a security that they do not own, with the intention to buy it back, at a later point in time. Covered short selling involves borrowing securities before making a sale, whereas naked short selling occurs when the investor has not borrowed securities prior to the short sale.

Obligations

SSR key requirements:
1. Banning short selling of shares and sovereign debt instruments that are not covered (naked short selling)
2. Significant net short positions must be reported to the relevant National Competent Authority (NCA) when they reach 0.2% of the share capital, and every 0.1% above or below that on an EU trading Venue. When the net short position is greater than or equal to 0.5% of the share capital, it is published.
3. National regulators have permission to temporarily restrict short selling in response to a significant price fall (short sell ban)
Exemptions are applicable for market making activities and authorised primary dealers.

Scope

The SSR applies to all financial instruments that are admitted to trading on a trading venue in the European Union, including such instruments when traded outside a trading venue. Financial Instruments include those listed in Annex I, Section C of Directive 2004/39/EC.

Brexit

Following the end of the transition period on 31 December 2020, the Financial Conduct Authority converted the EU SSR and the Level 2 regulation EU 918/2012 into UK domestic law. Technical Standards have also been converted to UK law.

On 6 January 2021, the UK Treasury published the Short Selling (Notification Thresholds) Regulations 2021 No. 5 (the Regulations) to amend the notification threshold under Article 5(2) of the Short Selling Regulation from 0.2% to 0.1% of the issued share capital of an issuer. This change comes into force on 1 February 2021.

Impact on Securities Lending

Securities Lending itself is not captured under SSR, it is however key to the process of short selling. ISLA believe that like securities lending, short selling is a crucial contributor to efficient capital markets by increasing liquidity, improving market stability, and promoting price discovery. In 2019, ESMA released a Report on ‘Undue short-term pressure on corporations’, in which it states:

‘ESMA has considered the general arguments in relation to the impact of short-selling and securities lending practices and their potential link with short-termism. Nevertheless, ESMA points out that short-selling and securities lending are key for price discovery and market liquidity. Moreover, ESMA is not aware of concrete evidence pointing to a cause-effect connection between these practices and the existence of undue short-term market pressures. Additionally, the Short Selling Regulation foresees the right of NCAs and ESMA to adopt emergency measures that may even restrict the capacity of market participants to sell short financial instruments temporarily where a threat to the financial stability or to market confidence may exist.’

Can a Short Sale be Covered by a Securities Lending Transaction?

Yes, a short sale can be covered by a securities lending transaction if the securities are delivered to the borrower, prior to the short sale as per Article 12 (1)a of the EU SSR.