Alert July 10, 2012

Short Selling – European Listed Shares and Sovereign Debt

With this article, we are pleased to extend the Financial Services Alert’s coverage to include certain key European developments relevant to US firms doing business cross border into Europe or with European clients.

The European Commission’s package of measures dealing with short selling is nearly complete, and the scope of the restrictions that will apply from November 1, 2012 is now clear.  This article considers the restrictions as they will apply to non-European persons trading outside the EU either in securities listed on exchange in the EU and/or in European sovereign debt.  The restrictions will apply irrespective of whether the trades actually take place on that European exchange.

The obligations apply also to non-European investment managers on an net aggregated basis where their underlying funds or portfolio management clients have short positions.

The measures consist of the substantive Regulation (No. 236/2012) and four implementing regulations that can all be found on the European Commission’s webpage here.


Key features of the requirements are as follows:

  • Holdings of any short position (ignoring any stock borrowing agreements in place) of more than 0.2% (and each 0.1% above that) in the issued share capital of a company listed in the EU must be disclosed to the regulatory authority of the state in which the share is listed.  Short positions of more than 0.5% must also be publicly disclosed.  Persons who have a net short position in sovereign debt issued by an EU sovereign issuer must disclose that holding to the relevant country’s competent authority, although the disclosure threshold will vary depending an on the amount of outstanding debt issued by the sovereign entity (0.1% if the amount outstanding is 500 billion euros or less; 0.5% otherwise).  Disclosure under these rules must be made in the standard form set out in the implementing regulation.
  • A person may enter into a short position in listed shares or sovereign debt only where it has made provisions to borrow the relevant security.  In other words, naked short positions are prohibited.  For these purposes, “borrowing” would include derivative contracts leading to physical settlement.
  • Transactions in sovereign credit default swaps are permitted only in circumstances where they do not lead to an uncovered position.  In other words transactions are permitted only to hedge existing exposures.  The definition of a credit default swap (CDS) in the Regulation is broad enough to capture other similar financial instruments such as, for example, credit-linked notes.  It is worth noting that the definition of a prohibited “uncovered position” is narrower than the concept of exposure, however.  A person may have an exposure to the risk of default of a sovereign issuer other than just holding the relevant debt securities.  For example, a person who has shares in banks that have lent heavily to indebted countries is exposed to the risk of default; the purchase of a CDS on the relevant debt may therefore be permitted notwithstanding that the purchaser held no government debt directly.
  • The local regulatory authority has the power to prohibit or restrict any form of  short selling of any financial instrument if the price of that instrument has declined “significantly” during a trading day in order to prevent a “disorderly decline in the price” of that instrument.  For liquid shares and bonds, this figure shall be at least 10%.

There are two relevant exemptions to the above restrictions:

  • Where the principal trading venue is located in a non-European third country.  This will be an important provision for non-EU traders since they are more likely to be dealing in securities that are duly listed both in and outside the EU than would be a European person.  Whether the security is listed on a principal trading venue outside the EU will be a question of fact since the relevant European regulatory authorities will publicly determine where the principal trading venue is located for each share traded on a European market.  It will then be a matter of checking this publicly available list to determine where the principal venue is located and, therefore, whether this exemption is available.
  • The provisions do not apply to market makers or to authorised primary dealers. Such persons are subject, however, to a requirement to notify the competent authority of the main trading venue in the union in which it trades at least 30 days before using the exemption or it will not be available.