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EU regulators adopt CDS short selling rules


21 February 2012 Brussels
Reporter: Anna Reitman

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Image: Shutterstock
The European Council has adopted rules which introduce common EU disclosure requirements and harmonise powers in "exceptional circumstances". The decision was taken without discussion at a meeting of the Economic and Financial Affairs Council meeting. The United Kingdom abstained, the European Council (EC) said in a statement.

"The regulation - which also had to be agreed by the European Parliament - covers all types of financial instruments, but given the potential risks posed by short selling this form of trading is a central element to be governed by the new rules," the EC said.

Transparency rules dictate that for significant net short positions in shares of EU listed companies, the regulation creates a two-tier reporting model. At a lower threshold, positions must be reported privately to regulators so that the latter can detect and investigate short sales that might constitute abuse or create systemic risks. At a higher threshold, positions must be disclosed to the market in order to provide useful information to other market participants.

For sovereign debt, significant net short positions relating to issuers in the EU will always require private disclosure to regulators.

EC said the regulation is intended to address issues arising from regulatory arbitrage which occurred in the wake of the 2008 financial crisis, when governments implemented a variety of national rules without pan-European coordination. At the same time, the regulation is also intended to acknowledge the role of short selling in ensuring the proper functioning of financial markets, in particular in providing liquidity and contributing to efficient pricing.

To tackle the increased risks posed by uncovered short sales, the proposal requires that anyone entering into a short sale must at the time of the sale have borrowed the instruments, entered into an agreement to borrow them or made other arrangements to ensure they can be borrowed in time to settle the deal.

However, these restrictions don't apply to the short selling of sovereign debt if the transaction serves to hedge a long position in debt instruments of an issuer. Moreover, if the liquidity of sovereign debt falls below a specified threshold, the restrictions on uncovered short selling may be temporarily suspended by the competent authority.

ESMA's role as a coordinating body was affirmed as well. The EU financial markets regulator is currently in consultation with stakeholders on implementation of these rules. ESMA expects a final report and submission of the draft advice to the Commission by mid-April with regulations due to enter into force in November, which will then be binding across all EU member states.
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