June 2012

LEGAL EASE: Short-selling regime to start

EEAThe European Union will have implemented its short-selling regime by November 2012. A major requirement will be for disclosure of net short positions in listed shares and sovereign debt within the European Economic Area (EEA).

So-called naked credit default swaps (CDS) on EEA sovereign debt will also be banned. Secondary provisions for the regime are being finalised, so certain details set out below may change between now and then.

The disclosure regime covers physical and synthetic short positions as well as positions held through baskets, index derivatives and exchange-traded funds.

For EEA-listed shares, the regime provides for private disclosure to the relevant local regulator at 0.2% and each successive 0.1% threshold, and public disclosure to the market at 0.5% and each successive 0.1% threshold. For EEA sovereign debt, there is only private disclosure and the thresholds are still to be set. 

CDS on EEA sovereign debt must be included in the short position calculation. Purchases of protection are treated as short positions; sales are treated as long positions.

A short position in a sovereign issuer can be reduced by a long position in another highly correlated EEA sovereign issuer.

Where the ban on naked CDS positions is suspended, these must be included in the calculation for sovereign debt and be disclosed separately if they cross a threshold in their own right. The thresholds are the same as for sovereign debt.

Position calculation
The holder of the position is primarily responsible for calculating and disclosing it. For fund managers, short positions should be calculated at fund level and disclosed at manager level. The manager must calculate the aggregated net short position for all funds and portfolios it manages for which the same “investment strategy" is pursued. For this purpose, an investment strategy is either long or short in an issuer. Therefore, only funds having a net short position shall be aggregated. The fund itself will not have a disclosure requirement.

For groups, short positions should be calculated for each group member individually and disclosed either at the level of the individual group member or at holding company level, depending on the circumstances. Group members who are fund managers must calculate the net position for the funds and portfolios they manage and are excluded from the calculation for the group as a whole. Positions must be calculated as at midnight and the deadline for disclosure is 3.30pm on the trading day following the day on which the net short position crosses a threshold.

Naked short selling bans
Physical short sales of EEA listed shares and EEA sovereign debt cannot be naked. The coverage requirements for shares differ depending on whether the shares are liquid and whether the investor intends to trade intra-day.  For liquid shares, a “locate” and “easy to borrow” confirmation from the broker will be sufficient.  If not, a “put on hold” confirmation will be required prior to trade. For debt, the coverage requirements range from a “locate” or “easy to purchase” confirmation to a more formal repo confirmation.

Naked CDS
Uncovered CDS referencing EEA sovereign debt are banned. A CDS is uncovered if held other than to hedge risk in a long position in the sovereign to which the CDS relates, or the risk of a decline in the value of the sovereign debt where the protection buyer has an exposure whose value is correlated to the value of the sovereign debt.

Naked CDS positions concluded before 25 March, 2012 can be held beyond 1 November, 2012 to expiry but cannot be rolled. Naked CDS positions concluded on or after 25 March, 2012 must be closed-out or covered by 1 November, 2012.

Among the exempted cases are short positions held by market makers and authorised primary market dealers. Also, shares admitted to trading on a regulated market or multi-lateral trading facility in the EEA will be excluded if the principal trading venue is outside the EEA.

Sarah Bowles is financial services partner and Geoffrey Rimington is senior professional support lawyer at Simmons & Simmons

©2012 funds europe