Why Short Selling Regulations Exist?

What are Short Selling Regulations?

Short selling is the practice of selling borrowed shares in the hope that they can be bought in the market at a lower price in the future to cover the negative (short) position – thus giving the firm a profit.

New EU regulations have been recently brought in to try and discourage the practice and halt the potential detrimental effects on the market. These regulations are seeking to address issues related to short-selling across the whole of the European economic area (EEA). They are also aimed at improving transparency, allowing regulators to monitor the practice and reduce the risk of settlement failure associated with the ownership of the instrument in question.

The Regulation Rules

Under the new rules, net short positions of 0.2% and above in eligible shares admitted to trading on a trading venue in the EU will need to be disclosed to the relevant competent authority. Net short positions of 0.5% and above will, in addition, need to be made publicly available

Necessary to the calculation of the net short positions is the inclusion of indirect holdings through related financial instruments, including derivatives (and index derivatives), depository receipts, ETFs (exchange traded funds) and baskets.

Sovereign debt must be reported to the applicable authority if a firm has short positions of 0.1% or 0.5% with the specific amount depending on the total outstanding issued sovereign debt.

One of the most important sections in the new regulations is the ability for regulators to temporarily prohibit or impose restrictions on short positions. If there is a sudden fall in price of a financial instrument on the trading floor it is possible to prohibit or restrict short sales in that instrument.

Uncovered short sales have been effectively prohibited by the new short selling regulations. Where a person enters into a short sale of share or sovereign debt, there must be an existing agreement to borrow the relevant stock.

Consequences

There were fears that the new regulations, which came into force in November 2012, would have a negative effect on trading. However, this has not been seen so far.

The FCA and other similar competent authorities have the power to impose penalties as a result of rule infringements , so it is imperative that the rules are understood and adhered to from the start.

Getting Help

There are certain exemptions that come into play in given circumstances, so understanding how it affects you can be difficult.

London Stock Exchange Group have articles on their website that break down the regulations clearly and concisely. The Exchange’s UnaVista platform can also help you understand your risk better by calculating the net short position several hours before each day’s deadline.

In addition, UnaVista offers data storage solutions and management that will give you a graphical overview of your positions and provide an automated service, ensuring consistency in adhering to the requirements of the regulation. 

April Orchid is a well known content provider in the business and finance industry. She is a close follower of financial regulation and the stock market, and writes on a range of technical subjects, from short selling to CRD IV.

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