Short Selling Regulations – Investment Funds
The Short Selling Regulation (Regulation (EU) No. 236/2012) (the “SSR”) and the European Commission Level 2 technical standards apply from 1 November 2012. The SSR has been given effect in Ireland through S.I. No. 340 of 2012 (The European Union (Short Selling) Regulations 2012.
The SSR aims to address certain systemic risk concerns with naked short selling raised at the height of the financial crisis in 2008.
Its objectives are to establish a harmonised and consistent approach by Member States in dealing with exceptional situations in the market place and to establish a common framework surrounding short selling and credit default swaps (“CDS”) within the European Union (“EU”).
The SSR applies to financial instruments admitted to trading on a trading venue in the EU (and where traded outside a trading venue); derivatives as defined in the Markets in Financial Instruments Directive (2004/39/EC) and debt instruments issued by a Member State.
The following are excluded from the definition of short sale under the SSR:
- futures contracts or other derivatives where there is an agreement to sell securities at a specified price at a future date;
- repurchase with specified pricing; or
- transfers under securities lending agreements.
In the context of investment funds, the SSR requires collective investment schemes to make regulatory notifications and public disclosures when the underlying financial instruments in funds managed reach or fall below the set thresholds. Specific guidance on the calculation of net short positions has been set out in the delegated regulations and summarised in this memorandum.
Net Short Positions
Under the SSR, short selling is only permitted if sellers have:
- borrowed the shares or sovereign debt;
- entered into a binding agreement to borrow the shares or sovereign debt; or
- an arrangement with a third party whereby they can reasonably expect to deliver the shares or sovereign debt they are selling (locate rule).
The key being that the shares or sovereign debt sold short is available for settlement.
Uncovered or naked short selling of sovereign CDS is prohibited under the SSR. However, short selling of sovereign CDS is permitted and deemed to be covered in circumstances where the shorting serves to hedge a long position in debt instruments of an issuer when the pricing has a high correlation with the pricing of the sovereign debt.
The delegated regulations set out details on the quantitative and qualitative tests required to prove this correlation.
The SSR requires information on net short selling of shares or sovereign debt to be notified to the relevant competent authority by 3:30pm on the day following the shorting once a reporting threshold has been reached.
In the case of shares the private regulatory reporting threshold is 0.2% of the company’s issued share capital and each 0.1% above that threshold. When the threshold has been reached or falls below the set levels, a private notification requirement is triggered.
The details of the content of such a private notification is set out in the delegated regulations and includes details of the position holder, their address, contact details, the reporting date, the percentage details and other information.
In addition, there is also a public disclosure requirement where information on net short positions will be available to the public in circumstances where the threshold of 0.5% of the company’s issued share capital and each 0.1% above that has been reached and also where it has fallen under. Details of the content of such notifications are set out in the delegated regulations and include the name of the position holder, name of the issuer, ISIN, percentage of net short position of issued share capital and the position date.
The information disclosed through the public notification will be posted on a central website operated or supervised by the relevant competent authority. The European Securities and Markets Authority (“ESMA”) will put a link to these central websites on its website.
Of relevance is that the notifications both private and public are not necessarily made to a regulated entity’s competent authority, rather the notifications are made to the competent authority in the jurisdiction of domicile of the principal trading venue where the underlying shares or sovereign debt is listed.
The sovereign debt thresholds for private regulatory reporting notifications are set out in detail in the delegated regulations on a scaled basis depending on the total amount of outstanding issued sovereign debt (“ISD”) i.e. 0.1% threshold where ISD is between €0 and €500 billion and a 0.5% threshold where ISD is above €500 billion.
There is no public disclosure requirement in respect of sovereign debt as the publication of this information may have a detrimental effect on sovereign debt markets.
Practicalities for Investment Funds
Investment funds shorting shares or sovereign debt should be aware of their notification and disclosure obligations under the SSR. For example:
- generally notification to relevant competent authorities will be carried out by the investment manager;
- investment funds and managers may need to review current procedures in place to ensure notification is made;
- investment funds may also need to review legal agreements in place with delegates in order to determine which entity will calculate and duly notify where required; and
- systems should be reviewed to determine whether an entity can satisfy the five year retention requirements.
Chapter IV of the delegated regulations sets out the method for calculating net short positions in funds managed. Where funds are managed on a discretionary basis, the calculation and notification obligations will fall on the discretionary manager.
The net short positions will be calculated on an aggregate basis where the same investment strategy is pursued for a particular issuer and notifications will be made to the relevant competent authority when thresholds have been reached.
The calculation of net short positions needs to take account of economic interests, obtained directly and indirectly, through derivatives such as options, futures, indices, baskets of securities and exchange traded funds.
Notifications and Disclosures
ESMA has published lists of links to national websites relating to the notification and disclosure of net short positions:
The position holder in respect of Irish net short positions are required to register with the Central Bank of Ireland at least two business days before notifications are made.
The respective registration, notification and disclosure forms are available on the Central Bank of Ireland's website:
Subject to compliance with certain requirements, the SSR have issued some exempted categories from the notification and public disclosure requirements and include:
- firms carrying out market making or primary dealing activities; and
- where the principal trading venue is in a third country.
In order to use these exemptions certain notifications need to be made within the specified timeframes set out on ESMA’s website:
If you would like further information on the SSR or would like to discuss the potential implications for your business and the recommended measures to ensure adherence with the provisions of the SSR, please contact one of the individuals listed above or your usual Maples and Calder contact.