Short selling regulation needs some fine-tuning
05 June 2013 Paris
Image: Shutterstock
The EU鈥檚 new short selling regulation has had a positive effect on market transparency and reducing the risk of settlement failure in Europe, but adjustments do need to be made, the European Securities and Markets Authority (ESMA) has found.
ESMA was asked to carry out a review of the effects of the short selling regulation shortly after it was implemented in November 2012.
The authority looked at the effects of transparency requirements, uncovered short selling restrictions and any other temporary business restrictions.
It also assessed whether the regulation is fulfilling the needs of the market for transparency and regulators to carry out their supervisory mandates.
It had to deliver its findings by the end of this month, and did so in a report to the European Commission on 3 June.
The short selling regulation had 鈥渕ixed effects鈥� on the liquidity of EU stocks, 鈥渨ith a slight decline in volatility, a decrease in bid-ask spreads and no significant impact on traded volumes鈥�, according to an ESMA statement.
But price discovery speed 鈥渟eems to have decreased compared to the period before the entry into force of the regulation鈥�, although 鈥渙verall, settlement discipline has improved鈥�.
ESMA鈥檚 report said: 鈥淥verall, it seems that market participants had a tendency to settle on one side or the other of the threshold and avoid crossing it. This would suggest that holders鈥� behaviour is pre-determined, ie, over time a holder is sticking to its initial decision on whether to go public on a given position.鈥�
鈥淭his would mean that the public disclosure threshold has an effect on short-selling activities, and even though no strict conclusion is to be drawn from the available data, it can be suspected that some actors prefer to stay below the 0.5 percent threshold and not to disclose information on their short-selling activity.鈥�
ESMA鈥檚 statement added that the short selling regulation had 鈥渘o compelling impact on the liquidity of EU single name CDS and on the related sovereign bonds markets ... except in a few countries鈥�.
鈥淭he liquidity in European sovereign CDS indices has been somewhat reduced.鈥�
Steven Maijoor, chair of ESMA, said: 鈥淸Our] review has found that the introduction of the short selling regulation has had some positive effects in terms of enhancing market transparency and reducing risks of settlement fails in EU financial markets.鈥�
鈥淒ue to the short period of operation of the regulation, ESMA was subject to severe limitations in terms of available data and practical experience in supervision under the regulation. However, ESMA is advising the European Commission to consider adjusting a number of aspects in the regulation that do not alter its main elements.鈥�
ESMA recommended changing the way that net short positions in shares are calculated, and revisiting the method of calculation of net short positions in sovereign debt, particularly the duration-adjusted approach, and reviewing the thresholds for notifications.
For restrictions on uncovered short sales in shares and sovereign debt, ESMA recommended considering some adjustments to the regime to allow internal locate arrangements within the same legal entity.
It also suggested revisiting the issue of the definition of 鈥榣iquid shares鈥� for the purpose of locate arrangements at a later stage, when proper regulatory data on securities lending would be available.
The authority also looked at emergency short selling bans, such as the one that is in operation in Greece, recommending that they should be simplified and made more consistent in their application.
ESMA was asked to carry out a review of the effects of the short selling regulation shortly after it was implemented in November 2012.
The authority looked at the effects of transparency requirements, uncovered short selling restrictions and any other temporary business restrictions.
It also assessed whether the regulation is fulfilling the needs of the market for transparency and regulators to carry out their supervisory mandates.
It had to deliver its findings by the end of this month, and did so in a report to the European Commission on 3 June.
The short selling regulation had 鈥渕ixed effects鈥� on the liquidity of EU stocks, 鈥渨ith a slight decline in volatility, a decrease in bid-ask spreads and no significant impact on traded volumes鈥�, according to an ESMA statement.
But price discovery speed 鈥渟eems to have decreased compared to the period before the entry into force of the regulation鈥�, although 鈥渙verall, settlement discipline has improved鈥�.
ESMA鈥檚 report said: 鈥淥verall, it seems that market participants had a tendency to settle on one side or the other of the threshold and avoid crossing it. This would suggest that holders鈥� behaviour is pre-determined, ie, over time a holder is sticking to its initial decision on whether to go public on a given position.鈥�
鈥淭his would mean that the public disclosure threshold has an effect on short-selling activities, and even though no strict conclusion is to be drawn from the available data, it can be suspected that some actors prefer to stay below the 0.5 percent threshold and not to disclose information on their short-selling activity.鈥�
ESMA鈥檚 statement added that the short selling regulation had 鈥渘o compelling impact on the liquidity of EU single name CDS and on the related sovereign bonds markets ... except in a few countries鈥�.
鈥淭he liquidity in European sovereign CDS indices has been somewhat reduced.鈥�
Steven Maijoor, chair of ESMA, said: 鈥淸Our] review has found that the introduction of the short selling regulation has had some positive effects in terms of enhancing market transparency and reducing risks of settlement fails in EU financial markets.鈥�
鈥淒ue to the short period of operation of the regulation, ESMA was subject to severe limitations in terms of available data and practical experience in supervision under the regulation. However, ESMA is advising the European Commission to consider adjusting a number of aspects in the regulation that do not alter its main elements.鈥�
ESMA recommended changing the way that net short positions in shares are calculated, and revisiting the method of calculation of net short positions in sovereign debt, particularly the duration-adjusted approach, and reviewing the thresholds for notifications.
For restrictions on uncovered short sales in shares and sovereign debt, ESMA recommended considering some adjustments to the regime to allow internal locate arrangements within the same legal entity.
It also suggested revisiting the issue of the definition of 鈥榣iquid shares鈥� for the purpose of locate arrangements at a later stage, when proper regulatory data on securities lending would be available.
The authority also looked at emergency short selling bans, such as the one that is in operation in Greece, recommending that they should be simplified and made more consistent in their application.
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