Proposed short selling disclosure regulations announced by the European Commission are too stringent and threaten market efficiency, according to the International Securities Lending Association.
Isla supports transparency measures that create disclosure symmetries with long positions, including private disclosure to regulators and anonymised reporting of aggregate reported positions, but believes the EC’s proposed public disclosure threshold of 0.5 per cent for short sales is too low.
“Evidence from prime brokers and market studies show that short selling activity is artificially reduced by investors seeking to avoid short selling above public disclosure thresholds. This undermines market efficiency by reducing liquidity and price discovery, while also widening dealing spreads,” says Kevin McNulty, chief executive of Isla.
“This ultimately results in more expensive and risky investment conditions, while also lowering securities lending volumes and the returns available to long term institutional investors such as pension funds.”
While in agreement with the EC’s desire to harmonise short selling regulations, Isla is concerned that a number of its proposals go beyond the framework of the original consultation and are excessive including for naked short selling, flagging of short sales and for automated settlement buy-ins. A technical matter that also needs to be addressed is to make clear that an investor who sells shares that are on loan is not deemed to have entered into a short sale.
Isla believes the proposed EC requirement to locate and reserve shares before all short sales is unnecessary, adding additional costs and processes for little or no benefit. Isla also believes current conventions for locating shares and determining liquidity work well and there is no evidence of settlement problems caused by naked short sales.
Isla believes that the benefits of flagging short sales do not outweigh the considerable IT costs that firms and trading venues will incur.
Although Isla supports the principle of sensible settlement discipline, it believes the EC’s proposal for T+4 automated buy-ins are too draconian and will cause a reduction in securities lending activity and market liquidity, as investors hold back excessive quantities of securities to manage this requirement.
James Coiley, international finance partner at law firm Ashurst, says: "Although the text of the proposal is fairly balanced, ultimately it permits national regulators and ESMA to ban entry into CDS on as wide or as narrow a basis as they choose. So the test will be in the application of the new powers – one man’s ‘threat to market confidence’ is another’s rational response to over-leveraged sovereign balance sheets."
