EN    EN EN 
EN    EN  EUROPEAN COMMISSION 
Brussels, 15.9.2010 
SEC(2010) 1056 
  
COMMISSION STAFF WORKING DOCUMENT 
SUMMARY OF THE IMPACT ASSESSMENT  
 
 
Accompanying document to the 
  
Proposal for a  
 
REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL 
 
on Short Selling and certain aspects of Credit Default Swaps 
  
{COM(2010) 482 final} 
{SEC(2010) 1055}  
EN 2   EN 1. PROBLEM DEFINITION  
At the height of the financial crisis in  autumn 2008, competent authorities in the 
United States and several EU Member St ates adopted exceptional measures to 
restrict or ban short selling in  some or all shares. They acte d due to concerns that at a 
time of considerable financial instability, short selling was aggravating the downward spiral in the prices  of shares, notably in fina ncial institutions, in a way 
which could ultimately thre aten their viability and create systemic risks. The 
measures adopted by Member States were divergent as the European Union lacks a 
specific legislative framework for d ealing with short selling issues.  
In March 2010, concerns were expressed by some governments also about the 
possible role played by derivative transacti ons, notably Credit Default Swaps (CDS), 
in relation to the prices for Greek soverei gn bonds. A number of Member States have 
adopted temporary or permanent restricti ons at national level on short selling and 
CDS.  
Short selling is the sale of a security th at the seller does not own, with the intention 
of buying back an identical secu rity at a later point in time  to be able to deliver the 
security. It can be divided into two types: "covered" short selling where the seller has 
made arrangements to borrow the securities be fore the sale and "n aked" short selling 
where the seller has not borrowed the secu rities when the short sale occurs. In 
addition to short selling on cash markets, a net short position can also be achieved by 
the use of derivatives, whether they are traded on exchanges or over-the-counter 
(OTC). 
A Credit Default Swap (CDS) is a deriva tive which acts as a form of insurance 
against the risk of credit de fault of a corporate or a government. In return for an 
annual premium, the buyer of a CDS is protected against the risk of default of a 
given reference entity by the seller. If th e reference entity defaults, the protection 
seller pays the buyer the par value of th e instrument in exchange for physical 
delivery of the reference instrument, a lthough settlement may also be by cash. 
1.1. Risk of negative price spirals 
Short selling can lead to more efficient price formation by preventing the prices of 
securities from reflecting only the views of the most optimistic investors. However, 
especially in distressed mark ets when financial confidence is lacking, there is a risk 
of short selling creating the impression that there is more supply on the market than 
there really is, and thereby inciting others to  sell ('herding behaviour'). This can lead 
to excessive downward pressure on the price of securities. The ri sk of negative price 
spirals becoming self-fulfilling, which can lead to disorderly markets and even 
systemic risks, is the main concern of regulators with regard to short selling. 
In addition to short selling on cash markets,  derivative transactions such as CDS can 
also be used to secure an economic shor t position. Buying a CDS without holding an 
underlying insurable interest ('naked CDS') is economically equivalent to short selling a bond, as the buyer benefits if  the price of the CDS goes up. Several 
governments and regulators in Europe have expressed conc erns with regard to CDS 
EN 3   EN and their interaction with bond markets, and the fear that this could cause mispricing 
on bond markets and thus higher funding costs for governments.  
1.2. Risk of settlement failure associ ated with naked short selling 
The risk of the short seller failing to deliv er the shares to the buyer by the settlement 
date, as well as a risk of increased price volatility, are the main risks associated by 
some regulators with naked short selling. Data on settlement failures is very limited, but suggests low levels in Europe. A majority of regulators said eith er that they have 
little experience of naked short selling or of  related settlement problems, or that the 
risks were limited and could be addresse d by settlement discipline. However, some 
regulators do perceive a risk  of settlement failure, as well as a greater risk of 
increased price volatility, with naked shor t selling which should be addressed. These 
regulators expressed concern that in ex treme cases naked short selling can put 
enormous pressure on share prices, which can  endanger the stability of the financial 
system. This is because naked short selling en ables the seller to sell, in principle, an 
unlimited number of shares in a very short space of time as they do not have to first 
borrow or locate the shares. 
1.3. Transparency deficiencies  
In most EU Member States there are curre ntly no disclosure requirements for short 
selling or CDS transactions, so these Member States have no direct access to data on 
the short positions held in their jurisdic tions; although as a result of the financial 
crisis, a number of Member States have in troduced different shor t selling disclosure 
requirements. Regulators have expressed concern that this situation makes it difficult 
for them to detect the build-up of positions which could have implications for the stability of markets. Disclosure to the regulator could help regulators to identify 
when this is occurring, and deter aggressi ve strategies which could contribute to 
disorderly markets.  
There is also a risk of information asym metries between informed short sellers and 
other less informed market participants. Disclosure to the market provides information to other market participants  about the price movements which short 
sellers expect and this could improve the e fficiency of price discovery. Transparency 
to the market would also ensure that mo re information about the opinions that 
investors hold on a particular security w ould be made available to all investors 
Concern has also been expressed by some re gulators that speculators may be driving 
down the prices of government bonds by us ing Credit Default Swaps (CDS). The 
concern of these regulators is that in th e absence of information about sovereign 
derivative and bond transactions it is more di fficult for them to detect the build-up of 
positions which could cause financial instability, as well as possible market abuse.  
1.4. Regulatory arbitrage and increased compliance costs 
The fragmented responses of Member States to issues relating to short selling leave 
scope for regulatory arbitrage, as investors could seek to circumvent restrictions in 
one jurisdiction by carrying out transact ions in another. This regulatory 
fragmentation could also lead to increased  compliance costs for market participants, 
especially those operating on several market s, who would have to set up different 
systems to comply with different requir ements in different Member States.  
EN 4   EN 2. THE BASELINE SCENARIO AND SUBSIDIARITY  
If no action is taken at EU level the problems defined above are likely to remain 
without a coordinated respons e and to occur again in the future. The European 
Commission considers that the solutions  proposed respect the principle of 
subsidiarity. First, because th ere is a real risk of nationa l responses to short selling 
and CDS being circumvented or ineffec tive in the absence of EU level action. 
Second, such uncoordinated measures are also  more costly to market participants. 
Finally, certain aspects of this issu e are already partly covered by the acquis , notably: 
the Market Abuse Directive, the Transparency Directive, and the Markets in Financial Instruments Directive. Theref ore a proposal on short selling and these 
existing legal instruments should complement each other.  
3. O
BJECTIVES  
In light of the analysis of the risks and problems above, the general objectives of the 
legislative proposal on short selling are to redu ce the risks to financial stability, 
systemic risks and risks to market integrity arising from short selling and to prevent market fragmentation, thereby increasing the efficiency of the internal market. .  
Reaching these general objectives requires the realisation of the following more 
specific policy objectives: 
(1) Reduce the risks of negative price sp irals arising from short positions 
(including those obtained through CDS) 
(2) Increase the transparency of short pos itions (including those obtained through 
CDS); 
(3) Reduce settlement risk linked with 'naked' short selling; and 
(4) Reduce the scope for regulatory arbitrage and compliance costs. 
4. P
OLICY OPTIONS  
The policy options are grouped according to  the operational objectives which flow 
from the above-mentioned specific objectives. 
4.1. Policy options to ensure regulators have clear power to restrict or ban short 
selling or CDS in distressed markets 
(1) Option 1 – take no action at EU level. 
(2) Option 2 – introduce a power for national competent authorities to 
temporarily restrict short selling in a financial instrument admitted to trading on an organised market whose price has fallen by a specified quantitative 
threshold, e.g. 10% ('circuit breaker'). 
(3) Option 3 – introduce a rule that prohi bits short sellin g of a financial 
instrument admitted to trading on an organised market except at a price above 
EN 5   EN the last traded price of the instrument, or  at the last traded price if that price 
was higher than the price in the pr evious trade (an 'uptick rule'). 
(4) Option 4 - introduce a ban on 'naked CDS'  (i.e. entering into a CDS contract 
without having an underlying insurable in terest). Compatible with 2 and 3. 
(5) Option 5 – grant national competent authorities the power to temporarily 
restrict or ban short selling of some  or all financial instruments or CDS 
transactions in exceptional situat ions, with coordination by ESMA in 
accordance with article 6a (5) of Regulation ??/EC establishing ESMA, and 
without prejudice to ESMA's powers under article 10 of this Regulation. Compatible with 2, 3 and 4. 
(6) Option 6 – introduce a permanent ban on short selling of all financial 
instruments capable of being so ld short. Compatible with 4. 
(7) Option 7 - introduce permanent restricti ons or ban on CDS. Compatible with 
2, 3 and 6. 
4.2. Policy options to ensure regulators and ma rkets obtain data on short positions 
(including through CDS). 
(1) Option 1 - take no action at EU level 
(2) Option 2 - introduce a system of flagging of short sale  transactions so that 
regulators can identify which transacti ons are 'long' and which are 'short'. 
(3) Option 3 - notification of short positions  to the regulator. Compatible with 2. 
(4) Option 4 - disclosure of short positions  to the public. Compatible with 2 and 
3.  
(5) Option 5 - aggregated disclosure of s hort positions (i.e. individual short 
positions of investors are not disclosed). Compatible with 2, 3 and 4. 
(6) Option 6 - disclosure of i ndividual significant net s hort positions. Compatible 
with 2, 3 and 4. 
(7) Option 7 - exemption from disclosure requirements for market making 
activities and certain primary market  operations. Compatible with 2-6. 
4.3. Policy options to ensure certain requirem ents at the point of trading and 
strengthen settlement discipline 
(1) Option 1 - take no action at EU level. 
(2) Option 2 - introduce a requirement that before entering into a short sale, a 
person must have borrowed the share, entered into an agreement to borrow 
the share or have other arrangements whic h ensure that he will be able to 
borrow the share at the time of settlement (locate rule) 
(3) Option 3 – introduce EU rules on settlement discipline so that persons 
engaging in short sales which result in  a failure to deliver face appropriate 
EN 6   EN penalties, with buy-in procedures and fines in case of settlement failures. 
Compatible with 2. 
(4) Option 4 - introduce a ban on naked short selling 
(5) Option 5 - exemption for market making activities and certain primary market 
operations. Compatible with 2, 3 and 4. 
4.4. Policy options to ensure a coordinated res ponse by EU member states to short 
selling and CDS 
This objective should be met by the above th ree categories of targeted options. In 
addition, the choice of legal instrument should also aim to ensure coordinated 
national responses. 
5. ASSESSMENT AND COMPARISON OF THE OPTIONS  
The different policy options were tested agai nst the criteria of th eir effectiveness and 
efficiency in achieving the related objectives. The comparison of policy options lead to the following conclusions: 
– Clear powers : the preferred option is a combination of option 5 (emergency 
powers), and option 2 (circuit breaker). A combination of the two options would 
give regulators an instrume nt to impose a short term  ban on short selling on 
organised markets in the event of a si gnificant price decline as well as the 
possibility to impose a temporary ban of  a longer duration, ca pturing derivatives 
as well, in the event of an exceptional situation.  
– Transparency : the preferred option is a combinat ion of options 2, 3, 4, 6 and 7. By 
combining options 3 and 4, the objective of  transparency for both regulators and 
the market would be achieved fully. In a ddition, a higher threshold for notification 
to the market would mitigate any impact on liquidity, while ensuring that regulators obtain the data they require.  Option 6 (individual disclosure) should 
also be part of the preferred option, as it meets the objectives more fully by 
providing the market with more detailed  transparency. Option 2 (flagging) would 
complement disclosure very effectively by providing regulators with real time 
data on all short positions, thereby capturing intraday positions and helping regulators with enforcement. Finall y, option 7 (market making and primary 
market operations exemption) would ensure  that the important liquidity provision 
function of these activities would be able to continue, which would mitigate any potential impact on liquidity of disclosure. 
– Settlement discipline : the preferred option is a comb ination of options 2, 3 and 5. 
If options 2 and 3 were combined, settlement discipline would be reinforced both by requirements at the point  of trading and by buy-in procedures and fines, 
thereby meeting very effectively the re lated operational objective. By combining 
option 5 with options 2 and 3, the potential negative impact on liquidity would be mitigated by a harmonised exemption for market making, and so would the potential for regulatory arbi trage and compliance costs associated with different 
exemptions across the EU. 
EN 7   EN – Coordinated response : non-legislative cooperation is discarded because it would 
not provide an effective solution to unc oordinated national ac tions leaving scope 
for regulatory arbitrage and higher comp liance costs. A Regulation should be 
preferred to a Directive as it is immedi ately applicable, would ensure uniform 
rules throughout the EU and those concerne d by its provisions would be able to 
depend on them immediately. 
6. IMPACTS OF THE PREFERRED OPTIONS  
 Impact on stakeholders Effectiveness Efficiency 
Options 2 + 5 
(circuit breaker and 
powers in 
exceptional 
situations) (+++) regulators gain powers to ban 
short selling/CDS in exceptional 
situations and short term  
(+++) issuers' share price can be 
supported by a temporary ban on short 
selling in distressed markets 
(0) governments: reduced volatility on 
sovereign bond markets, but risk of 
negative effects on liquidity 
(- -) financial institutions may be 
temporarily restricted from short 
selling & face compliance costs (+++) achieves objective 1 
fully  
(+++) Objective 4: fully met 
(+++) avoids unduly 
negative effects on market 
efficiency  (-) reduced compliance 
costs due to 
coordinated EU approach; any effect on liquidity temporary 
 
Options 2+ 3 + 4 +6 
+ 7 
(flagging, 
notification to 
regulator and 
disclosure to market 
of individual net short positions, with 
exemption for 
market makers and primary market dealers) (+++) regulators: full transparency on 
short positions  
(+++) issuers: access to data on 
significant short positions and full 
benefit of liquidity provided by market makers 
(+++) individual investors: 
information asymmetries eliminated 
and liquidity provided by market 
makers maintained 
(+++) governments: liquidity in 
sovereign bonds not impaired 
(- ) financial institutions: compliance 
costs and likely to reduce short selling to avoid disclosure to public, but can 
continue market making activities (+++) Objective 2:fully met  
(+++) Objective 4: fully met 
(++) limits unduly negative 
effects on market efficiency  (- ) ongoing 
compliance costs; 
impact on market 
liquidity mitigated by 
thresholds and 
exemption 
Options 2+3+5 
(locate rule, and 
settlement discipline with exemption for 
market makers and primary market dealers) (+++) regulators can sanction naked 
short selling  
(+++) issuers: number of shares sold 
short cannot exceed the number issued 
or available to borrow, liquidity not impaired due to market maker exemption 
(+++) governments: number of 
government bonds sold short cannot 
exceed the number issued or available to borrow, liquidity not impaired due to market maker exemption 
(+ ) some financial institutions may 
have to adapt their compliance 
systems, but market making exempt (++) Objective of reducing 
settlement risk achieved by 
rules at the point of trading 
and settlement discipline 
(+++) Objective 4: met in 
full 
(+) Contributes to reducing 
risk of negative price spirals 
 (-) some ongoing 
compliance costs 
although many already operate locate rule; 
impact on liquidity 
mitigated by market 
maker exemption 
7. MONITORING AND EVALUATION  
The Commission will monitor how Member  States are applying the changes 
proposed in the legislative initiative on s hort selling. The evaluation of the legislative 
measure could take place three to five years af ter its entry into force, in the context of 
a report to the Council and the Parliament on the appropr iateness of the reporting and 
public disclosure thresholds.