COMMISSION STAFF WORKING DOCUMENT 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) 1056}
Date: 2010-09-15
Institutions: European Commission
Subjects: credit policy, financial instrument, financial legislation, financial market, financial policy, sale, swap arrangement

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EUROPEAN COMMISSION 

Brussels, 15.9.2010 
SEC(2010) 1055 

COMMISSION STAFF WORKING DOCUMENT 

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) 1056} 

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TABLE OF CONTENTS 

1. Introduction ............................................................................................................................ 5 

2. 

2.1. 

2.2. 

2.3. 

2.4. 

3. 

Procedural issues and consultation of interested parties .............................................. 7 

CESR and ESME reports ............................................................................................. 7 

Public consultation....................................................................................................... 8 

Steering Group ............................................................................................................. 8 

Impact Assessment Board ............................................................................................ 9 

Policy context, Problem Definition, Baseline scenario and Subsidiarity................... 10 

3.1. 

Background and context............................................................................................. 10 

3.1.1  Who short sells, what and why .................................................................................. 10 

3.1.2 

Trades in Credit Default Swaps ................................................................................. 14 

3.1.3 

Economic benefits of short selling and CDS ............................................................. 15 

3.1.4 

Stakeholders concerned by short selling and CDS transactions ................................ 17 

3.1.5  Overview of current regulatory landscape and how it may evolve............................ 17 

3.2. 

Problem definition...................................................................................................... 20 

3.2.1.  Other related issues outside of the scope of this initiative ......................................... 22 

3.3. 

3.4. 

3.5. 

3.6. 

3.7. 

3.8. 

4. 

4.1. 

4.2. 

5. 

5.1. 

5.2. 

Problem 1: Risk of negative price spirals .................................................................. 24 

Problem 2: Risk of settlement failure associated with naked short selling................ 26 

Problem 3: Transparency deficiencies ....................................................................... 28 

Problem 4: Increased compliance costs and potential regulatory arbitrage arising 
from a fragmented regulatory framework .................................................................. 30 

How would the problem evolve without EU action? The Baseline Scenario ............ 32 

Subsidiarity ................................................................................................................ 34 

Objectives................................................................................................................... 34 

General, specific and operational objectives.............................................................. 34 

Consistency of the objectives with other EU policies................................................ 37 

Policy options............................................................................................................. 37 

Policy options to ensure regulators have the power to restrict or ban short selling or 
CDS in distressed markets ......................................................................................... 37 

Policy options to ensure certain requirements at the point of trading and strengthen 
settlement discipline................................................................................................... 38 

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5.3. 

5.4. 

Policy options to ensure regulators and markets obtain data on short positions 
(including through CDS)............................................................................................ 38 

Policy options to ensure a coordinated response by EU member states to short selling 
and CDS ..................................................................................................................... 39 

6. 

Analysis of impacts and choice of preferred options and instruments....................... 39 

6.1. 

Analysis of impacts of policy options........................................................................ 39 

6.1.1.  Policy options to ensure regulators have the power to restrict or ban short selling or 

CDS in distressed markets ......................................................................................... 39 

6.1.2.  Policy options to ensure certain requirements at the point of trading and strengthen 

settlement discipline................................................................................................... 48 

6.1.3.  Policy options to ensure regulators and markets obtain data on short positions 

(including through CDS)............................................................................................ 55 

6.2. 

The preferred policy options and instrument ............................................................. 65 

6.2.1.  The preferred policy options ...................................................................................... 65 

6.2.2.  Choice of instrument to ensure a coordinated response by EU Member States to short 
selling and CDS ......................................................................................................... 66 

6.2.3. 

Impact on retail investors and SMEs ......................................................................... 67 

6.2.4. 

Impact on third countries ........................................................................................... 68 

6.2.5.  Social impact.............................................................................................................. 69 

6.2.6.  Environmental impact ................................................................................................ 69 

6.3. 

Estimate of impact in terms of compliance costs....................................................... 69 

7. 

8. 

9. 

9.1. 

9.2. 

10. 

11. 

12. 

13. 

14. 

Monitoring and Evaluation ........................................................................................ 72 

Annex 1 – Glossary of terms...................................................................................... 73 

Annex 2 – Summary of public consultation on Short Selling.................................... 76 

Summary of the responses ......................................................................................... 76 

List of contributors to public consultation ................................................................. 80 

Annex 3: Overview of measures in force in EU 27 on short selling/CDS................. 86 

Annex 4 – Summary of discussions between DG MARKT and CESR-POL on Short 
Selling, Paris, 14 April 2010 ...................................................................................... 88 

Annex 5 – List of organisations represented in meeting of commission services with 
market participants and public authorities on credit default swaps ........................... 94 

Annex 6 – regulatory regime in the united states on short selling ............................. 96 

Annex 7 – bibliography of recent economic literature on short selling, committee on 
economic and market analysis (CEMA), CESR ........................................................ 98 

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15. 

16. 

17. 

Annex 7 – Data on shares outstanding on loan as a proxy for volume of short selling 
transactions in the European Union, provided by dataexplorers.............................. 103 

Annex 8 – Estimate of compliance costs ................................................................. 106 

Annex 9 – Table providing an overview of the scope of preferred options............. 114 

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1. 

INTRODUCTION  

At  the  height  of  the  financial  crisis  in  autumn  2008,  competent  authorities  in  the 
United  States  and  several  EU  Member  States  adopted  exceptional  measures  to 
restrict or ban short selling in some or all shares1. They acted 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  financial  institutions,  in  a  way 
which  could  ultimately  threaten  their  viability  and  create  systemic  risks2.  The 
measures adopted by Member States were divergent as the European Union lacks a 
specific legislative framework for dealing with short selling issues.  

Since  that  time,  regulators  have  developed  through  the  Committee  of  European 
Securities  Regulators3  (CESR)  a  two-tier  regime  for  the  disclosure  of  short  selling 
transactions to regulators and the public4, which they have called on the Commission 
to include in a proposal for a new European legislative framework. Finally, concerns 
have  been  raised5  about  the  possible  implications  in  terms  of  settlement  risk  of  so-
called "naked short selling"6.  

Short selling is the sale of a security that the seller does not own, with the intention 
of buying back an identical security at a later point in time to be able to deliver the 
security7.  It  can  be  divided  into  two  types:  "covered"  short  selling  where  the  seller 
has  made  arrangements  to  borrow  the  securities  before  the  sale  and  "naked"  short 
selling where the seller has not borrowed the securities when the short sale occurs. 
Naked short selling is often used for intra day trading.  

The expression "short selling" is sometimes used in a more general sense to cover a 
broad range of actions that allow an investor to profit from a price decline in an asset. 

1 

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7 

Annex 3 includes a table giving an overview of the situation on key measures in the EU 27 taken from a note by 
CESR setting out the measures on short selling taken by Member States. 
For example, in Discussion Paper 09/1, Short Selling, February 2009, p. 3, the UK Financial Services 
Authority explained their reasons for introducing temporary short selling measures in September 2008 
as follows: "We did this at a time of extreme market turbulence, manifested in the forms of high and 
prolonged  price  volatility  and  downward  pressure  on  the  prices  of  financial  stocks  in  particular.  We 
were concerned by the heightened risks of market abuse and disorderly markets posed by short selling 
in these conditions."  
CESR is an independent advisory group to the European Commission composed by the national supervisors of the 
EU securities markets. See the European Commission's Decision of 23 January 2009 establishing the Committee of 
European  Securities  Regulators  2009/77/CE.  OJ  L25,  23.10.2009,  p.  18).  The  role  of  CESR  is  to  improve  co-
ordination among securities regulators, act as an advisory group to assist the EU Commission and to ensure more 
consistent and timely day-to-day implementation of community legislation in the Member States.  
Committee  of  European  Securities  Regulators,  Model  for  a  Pan-European  Short  Selling  Disclosure 
Regime, March 2010. The report advocates a two-tier model for disclosure of significant individual net 
short  positions  in  all  shares  that  are  admitted  to  trading  on  an  EEA  regulated  market  and/or  an  EEA 
MTF.  At  the  lower  threshold  of  0.2%,  positions  would  be  disclosed  to  the  relevant  regulator,  at  the 
higher threshold of 0.5% positions would be disclosed, in addition to the regulator, also to the market as 
a whole. 
On  8  June  2010,  President  Sarkozy  and  Chancellor  Merkel  wrote  to  President  Barroso  urging  the 
Commission to bring forward a legislative initiative on short selling and sovereign CDS encompassing 
the possibility of an EU wide prohibition of naked short selling and naked sovereign CDS . 
Responses  from  some  national  regulators  to  a  questionnaire  by  the  Commission  services.  The 
respondents wished their responses to remain confidential. A summary by the Commission services of a 
meeting with national regulators on short selling is included in annex 5. 
A glossary of key terms on short selling and Credit Default Swaps is included in annex 1. 

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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  derivative  which  acts  as  a  form  of  insurance 
against  the  risk  of  credit  default  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  the 
reference entity (stated in the contract) by the seller. If the reference entity defaults, 
the protection seller pays the buyer the par value of the instrument in exchange for 
physical  delivery  of  the  reference  instrument,  although  settlement  may  also  be  by 
cash. 

In  March  2010,  concerns  were  expressed  by  some  governments  also  about  the 
possible role played by derivative transactions, notably CDS, in relation to the prices 
for Greek sovereign bonds8. A number of Member States have adopted temporary or 
permanent restrictions at national level on short selling and CDS which are outlined 
in section 3.1.5. 

In light of concerns about the regulation of short selling and CDS, the Commission 
decided to include in its Work Programme for 2010 a legislative initiative on short 
selling  and  Credit  Default  Swaps  as  a  strategic  initiative9.  This  was  restated  in  the 
Commission  Communication  of  2  June  2010  on  Regulating  Financial  Services  for 
Sustainable  Growth.10This  impact  assessment  accompanies  the  proposal  for  a 
regulation on short selling and certain aspects of Credit Default Swaps. 

It is important to note that this initiative is not the only one to address problems in 
the markets highlighted by the current crisis. As announced in its Communication of 
2  June  2010,  the  Commission  will  complete  its  full  financial  reform  programme  in 
the  coming  months.  Of 
the 
Communication, a number are related to this initiative. 

the  existing  or  pending  proposals 

listed 

in 

The  proposal  for  a  Directive  on  Alternative  Investment  Fund  Managers11  aims  to 
create  a  comprehensive  and  effective  regulatory  and  supervisory  framework  at  the 
European  level,  providing  robust  and  harmonised  regulatory  standards  for  all 

8 

9 

10 

11 

In  a  joint  letter  dated  10  March  2010  to  President  Barroso  and  Prime  Minister  Zapatero,  President 
Sarkozy,  Chancellor  Merkel,  Prime  Minister  Juncker  and  Prime  Minister  Papandreou  wrote:  "We 
therefore propose that the EU Commission initiates as quickly as possible at European level an inquiry 
into  the  role  and  impact  of  speculative  practices  in  connection  with  CDS  trading  in  the  government 
bonds of European countries. Should the inquiry ascertain market abuses or that there is a well-founded 
suspicion that speculative practices are having a considerable impact on the development of yields, we 
should  quickly  examine  measures  to  determine  whether  they  are  suitable  and,  if  necessary,  pass  the 
appropriate legislation. These examinations should also consider introducing minimum holding periods 
for CDS trading, banning speculative CDS trading as well as banning the acquisition of CDS which are 
not being used for hedging purposes." 
Communication  from  the  Commission  to  the  European  Parliament,  the  Council,  the  European 
Economic  and  Social  Committee  and  the  Committee  of  the  Regions,  Commission  Work  Programme 
2010 – Time to Act, COM(2010) 135 final, Vol. 1, p. 4 and Annex I, p. 4.  
Communication  from  the  Commission  to  the  European  Parliament,  the  Council,  the  European 
Economic  and  Social  Committee  and  the  European  Central  Bank,  Regulating  financial  services  for 
sustainable growth, COM(2010) 301 final, 02.06.2010, p. 7. 
Proposal for a Directive of the European Parliament and of the Council on Alternative Investment Fund 
Managers and amending Directives 2004/39/EC and 2009/…/EC, COM(2009) 207 final, 30.4.2009. 

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managers  and  enhancing  transparency  towards  investors.  Concerning  effective 
supervision,  the  proposal  for  a  Regulation  establishing  a  European  Securities  and 
Markets Authority (ESMA)12 provides in its article 10 for ESMA to have the power 
to adopt individual decisions in emergency situations.  

In terms of enhanced transparency, a forthcoming proposal which is closely related 
to  the  initiative  on  short  selling  and  Credit  Default  Swaps  is  the  proposal  for 
legislation to improve the functioning of derivatives markets, which will strengthen 
the  EU's  financial  market  infrastructure,  promote  the  standardisation  of  derivatives 
contracts and develop central clearing parties for derivative contracts to substantially 
reduce  risk.  The  Commission  will  also  propose  improvements  to  the  Markets  in 
Financial Instruments Directive13 (MiFID) in order to strengthen pre- and post-trade 
market transparency and bring more derivatives onto organised trading venues.  

Finally,  in  the  context  of  strengthened  responsibility  and  consumer  protection,  the 
Market  Abuse  Directive14  will  be  revised  in  order  to  extend  its  rules  beyond 
regulated markets and to include derivatives in its scope of application. 

2. 

PROCEDURAL ISSUES AND CONSULTATION OF INTERESTED PARTIES 

The proposal for a regulation on Short Selling and certain aspects of Credit Default 
Swaps  and  its  impact  assessment  have  been  prepared  in  accordance  with  the 
Commission's better regulation principles. The proposal takes into consideration the 
observations  and  analysis  contained  in  the  reports  published  by  the  Committee  of 
European  Securities  Regulators  (CESR).  The  proposal  and  the  impact  assessment 
also take into consideration the comments received from stakeholders participating in 
a public consultation from 14 June to 10 July 2010.  

2.1. 

CESR and ESME reports 

DG  Internal  Market  services  asked  the  European  Securities  Markets  Expert  Group 
(ESME15),  an  independent  advisory  group  to  the  Commission  composed  of  market 
participants,  to  prepare  a  report  on  short  selling.  The  report  containing  a  series  of 
recommendations was adopted on 19 March 200916.  

12 

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14 

15 

16 

Proposal  for  a  Regulation  of  the  European  Parliament  and  of  the  Council  establishing  a  European 
Securities and Markets Authority, COM(2009) 503 final, 23.9.2009. 
Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in 
financial instruments, OJ L145, 30.04.2004. 
Directive  2003/6/EC  of  the  European  Parliament  and  of  the  Council  of  28  January  2003  on  insider 
dealing  and  market  manipulation  (market  abuse),  L  96/20,  12.04.2003.  Article  1.2  defines  market 
manipulation  and  article  5  requires  Member  States  to  prohibit  any  person  from  engaging  in  market 
manipulation. 
The  European  Securities  Markets  Expert  Group  (ESME)  was  established  by  Commission  Decision 
2006/288/EC  setting  up  a  European  Securities  Markets  Expert  Group  to  provide  legal  and  economic 
advice on the application of the EU securities Directives (30.03.2006). The objective of the Group was 
to  advise  the  Commission  on  various  issues  in  relation  to  the  EU  securities  markets.  The  Group 
consisted of 20 members, chosen according to strict procedures to ensure the widest possible range of 
professional backgrounds (such as lawyers, economists and accountants) and geographical balance so 
that  the  different  EU  markets  were  covered.  This  non-binding  advice  assisted  the  Commission  in 
fulfilling its tasks. ESME's mandate expired on 31.12.2009 and was not renewed.  
The full text of the report can be found at: 

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The  Committee  of  European  Securities  Regulators  (CESR)  consulted  in  the  second 
half  of  2009  on  a  possible  pan-European  model  for  the  reporting  and  disclosure  of 
net  short  positions  in  EU  shares17.  It  then  recommends  that  the  Commission 
introduces such a regime as soon as possible. CESR also published on 22 September 
2008  (updated  on  22  February  2010)  a  table  setting  out  the  measures  adopted  by 
national competent authorities on short selling.18 

DG Internal Market services held a meeting with CESR experts in Paris on 14 April 
2010 to consult national competent authorities on issues relating to short selling, net 
short  positions  and  CDS.  The  summary  of  the  discussion  is  included  in  annex  4. 
National  competent  authorities  also  responded  to  a  questionnaire  circulated  by  the 
Commission services in June 2010. 

The Commission services held two meetings on 5 March 2010 with representatives 
of  market  participants  and  national  competent  authorities  on  issues  relating  to 
sovereign CDS. The list of participants is included in annex 5. 

2.2. 

Public consultation  

In  April  2009,  the  European  Commission  asked  some  high  level  questions  on  a 
possible  regulatory  regime  for  short  selling in the context of a call for evidence on 
the  review  of  the  Market  Abuse  Directive  launched  on  20  April  200919.  Most 
contributors  responded  that  the  Market  Abuse  Directive  was  not  the  appropriate 
instrument  for  addressing  short  selling,  as  most  short  selling  does  not  constitute 
market abuse in the view of market participants.  

On  14  June  2010,  the  European  Commission  launched  a  public  consultation  on 
policy options for a possible legislative initiative on short selling. The Commission 
services  received  around  120  contributions.  The  non-confidential  contributions  can 
be  consulted  on  the  Commission's  website20.  The  outcome  of  the  consultation  has 
been summarised in Annex 2. 

2.3. 

Steering Group  

The Steering Group for this Impact Assessment was formed by representatives of a 
number  of  services  of  the  European  Commission,  namely  the  Directorate  General 
Internal  Market  and  Services,  the  Directorate  General  Competition,  the  Directorate 
General  Economic  and  Financial  Affairs,  the  Directorate  General  Enterprise,  the 
Directorate General for Health and Consumers, the Legal Service and the Secretariat 
General. This Group met three times, on 18 May 2010, 7 July 2010 and on 23 July 

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20 

http://ec.europa.eu/internal_market/securities/docs/esme/report_20090319_en.pdf  
CESR/10-088, March 2010, c.f. footnote 4. 
Committee  of  European  Securities  Regulators,  CESR/08-742,  Measures  adopted  by  CESR  Members  on 
short selling, 22 September 2008, updated 22 February 2010 
Call for evidence, Review of Directive 2003/6/EC on insider dealing and market manipulation (Market 
Abuse Directive). For the text of the call for evidence, see: 
http://ec.europa.eu/internal_market/consultations/docs/2009/market_abuse/call_for_evidence.pdf 
See http://ec.europa.eu/internal_market/consultations/2010/short_selling_en.htm  

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2010. The contributions of the members of the Steering Group have been taken into 
account in the content and shape of this impact assessment21.  

2.4. 

Impact Assessment Board  

DG  MARKT  services  met  the  Impact  Assessment  Board  on  30  August  2010.  The 
Board analysed this Impact Assessment and delivered its opinion on 31 August 2010. 
During this meeting the members of the Board provided DG MARKT services with 
comments  to  improve  the  content  of  the  Impact  Assessment  that  led  to  some 
modifications of this final draft. These are:  

–  Modifications  to  highlight  the  problem  of  fragmented  regulatory  approaches  to 
short  selling  and  CDS  and  the  added  value  that  the  EU  can  bring  in  creating  a 
common  European  framework  to  ensure  the  smooth  functioning  of  the  single 
market; 

–  A clearer distinction between risks which regulators have expressed concern about 
and which should be the subject of EU action as part of a precautionary approach, 
and problems for which empirical evidence exists; 

–  A  more  detailed  explanation  of  the  nature  of  EU  level  coordination  and  the 
respective  roles  of  national  competent  authorities  and  ESMA,  particularly  with 
regard  to  the  circuit  breaker  and  measures  in  exceptional  situations,  and 
clarification  of  how  implementing  measures  will  be  used  to  further  specify 
exceptional situations; 

–  Clarification of which financial instruments are covered by each preferred option, 
notably through the addition of an overview table in the annexes, as well as of the 
explanation and presentation of some of the options; 

–  A fuller explanation of the rationale for exempting market making activities and 
how  this  option  will  be  implemented  so  as  to  ensure  the  effectiveness  and 
efficiency of the legislation; 

–  Clarification of how cooperation with non-EU authorities would ensure effective 

implementation and compliance; 

–  Clarification of the analysis of compliance costs; 

–  The inclusion of a more comprehensive glossary of key terms. 

21 

In  accordance  with  the  rules  for  the  elaboration  of  impact  assessments  the  minutes  of  the  last  meeting  of  the 
steering group have been submitted to the Impact Assessment Board together with this impact assessment. 

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3. 

POLICY CONTEXT, PROBLEM DEFINITION, BASELINE SCENARIO AND SUBSIDIARITY 

3.1. 

Background and context 

3.1.1  Who short sells, what and why  

Short selling is not a new phenomenon – it has been a feature of equity markets since 
at least the 17th century, when short sellers were accused of causing the collapse of 
shares in the Dutch East India company in 1609, and  short sellers were accused of 
causing the 1929 stock market crash, which led to legislation in the United States to 
regulate short selling22. 

In theory, a variety of different financial instruments are capable of being sold short: 
shares,  credit  instruments,  interest  rates,  currencies  or  commodities.  However,  in 
practice short selling is more widespread and can be conducted more easily for some 
instruments than others, and the evidence of risks, or concerns about potential risks, 
is  greater  for  some  instruments  (i.e.  shares)  than  for  others.  With  the  exception  of 
Credit  Default  Swaps,  which  are  examined  in  more  detail  in  section  3.1.2.  below, 
derivatives will be considered in relation to their underlying instruments, as it is from 
this  underlying  instrument  that  they  derive  their  value.  Also,  in  most  cases 
derivatives  cannot  really  be  sold  short,  but  they  can  be  used  to  create  a  position 
which is economically equivalent to short selling the underlying instrument. 

Short selling in shares 

Short  selling  is  used  by  a  variety  of  market  participants  including  hedge  funds, 
traditional  fund  managers  such  as  pension  funds  and  insurance  companies, 
investment  banks,  market  makers  and  individual  investors.23  Short  selling  can  be 
used for speculative purposes, to hedge a long position, for arbitrage and for market 
making.  Examples  of  different  reasons  for  short  selling  are  provided  in  the  box 
below. 

22 

23 

Short sellers have been the villains for 400 years, Reuters, 26.09.08 
Factbox: milestones in short selling history, Reuters, 16.07.08 
Discussion Paper 09/1, Short Selling, February 2009, Financial Services Authority, pp. 7-9 for a more 
detailed analysis of who short sells and why.  

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Examples of reasons for short selling24 

Speculation: for example, an investment bank trading for its own book ("proprietary trading") 
may  sell  a  share  short  because  it  believes  the  price  will  decline,  in order  to profit  from  that 
decline by buying back the share at the lower price. However, short selling is a risky strategy, 
as  if  the  share  price  rises  instead  of  falling,  then  the  short  seller  will  have  to  close  out  the 
position at a loss or pledge more collateral to keep the position open. 

Hedging:  although  pension  funds  and  insurance  companies  tend  to  buy  shares  in  order  to 
profit  from  their  (anticipated)  rise  over  the  long  term,  they  often  hedge  their  risk  by  selling 
short comparable shares to those in which they hold a long position. If the share price in their 
long position goes down, then they can limit their losses through the rise in the value of the 
short position. This is a common practice in most developed financial markets. 

Arbitrage: for example when a hedge fund combines a short position and a long position in 
two different but inter-related shares, to make a profit from the price differential between the 
two shares. 

Market making: in order to meet customer demand for securities which are not immediately 
available, market makers use short selling to fill client orders, i.e. to provide liquidity to the 
market. 

Estimates of the volume of short selling of shares vary widely. Some studies estimate 
that  short  selling  in  the  United  States  accounts  for  between  14  and  30%  of  equity 
trading  volume25.  Studies  also  show  that  short  selling  volume  can  be  considerably 
higher in the US, particularly in shares of financial institutions at times of financial 
instability;  for  example,  short  sales  of  shares  in  some  US  financial  institutions 
exceeded 40% of trading volume in those shares in summer 200826.  

The  availability  and  reliability  of  data  on  the  volume  of  short  selling  in  Europe  is 
limited  in  the  absence  of  marking  of  transactions  or  disclosure  regimes,  and  of 
reporting of over the counter transactions27. In the consultation of regulators carried 
out  by  the  Commission  services,  most  regulators  who  responded  did  not  have  any 
data  on  the  volume  of  short  selling  transactions  on  their  markets  or  reported  very 
little  or  no  short  selling  on  their  markets.  However,  regulators  in  some  Member 

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26 

27 

Ibid. 
"For the control stocks that are never subject to the shorting ban, NYSE short sales account for a cross-
sectional average of 14.12% of NYSE trading volume during the pre-ban period from 1 August through 
18  September  [2008]",  Boehmer,  Ekkehart;  Jones,  Charles;  and  Zhang,  Xiaoyan,  Shackling  short 
sellers: the 2008 shorting ban, working paper, 18 November 2008, p. 7. "Short sellers account for more 
than  20%  of  trading  volume",  Boehmer,  Jones  and  Zang,  2008,  quoted  in  Boehmer  and  Wu,  Short 
selling  and  the  informational  efficiency  of  prices,  2009,  p.  1.  "Some  estimates  have  short  sellers 
responsible for between 20-30% of equity trading volume", Oliver Wyman, The effects of short-selling 
public disclosure regimes on equity markets, 2010, p. 6. 
Analysis of the Pre-Borrow Emergency Order, Memorandum by the Office of Economic Analysis, 14 
January 2009, p. 6. According to the US Office of Economic Analysis, short selling in the 17 NYSE 
listed  financial  stocks  subject  to  a  pre-borrowing  requirement  on  short  sales  represented  41.81%  of 
trading volume in those stocks from 12 June to 11 July 2008. This fell to 30.74% after the introduction 
of the pre-borrow requirement on 15 July 2008. 
In contrast, the United States has a marking regime and provides for reporting of OTC transactions. The 
latter is an option which will be considered in the context of the review of the Directive on Markets in 
Financial  Instruments.  One  Member  State,  the  UK,  currently  requires  OTC  transaction  reporting  at 
national level. 

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States were able to provide some data, notably the UK, Spain and Greece, and data 
on securities lending, which can serve as a proxy for short selling, has been provided 
by  Dataexplorers  (see  annex  7).  For  the  UK,  the  FSA  provided  data  on  securities 
lending as a percentage of market capitalisation as a proxy for the volume of short 
selling  stock  lending;  according  to  this  data,  securities  lending  averaged  between  1 
and  3%  of  market  capitalisation  between  August  2006  and  August  2009 
(disregarding  spikes  which  the  FSA  attributes  to  dividend  payment  periods).  Since 
according to the FSA a large proportion of securities lending is for tax purposes, this 
data suggests lower levels of short selling. The UK FSA also provided data based on 
disclosure  of  significant  short  positions  in  financial  sector  shares  only  between 
January and May 2009; this showed that the largest proportion of short positions was 
in the range of 0.25-0.35% of the total share capital of the issuer, i.e. just above the 
UK disclosure threshold of 0.25%28.  

For Spain, the CNMV provided data from the Spanish clearing house Iberclear using 
securities  lending  as  a  proxy  for  covered  short  selling.  This  data  showing  that 
covered  short  selling  activity  in  shares  amounted  to  1.4%  of  the  total  number  of 
trades in 2009, essentially stable from the figure in 2007, which was 1.36% . In terms 
of  value,  short  selling  represented  6.47%  of  trading  in  2009,  again  broadly  stable 
from the figure of 6.35% in 2007. This data appears consistent with that provided by 
the UK and also using securities lending as a proxy. Based on the disclosure of short 
positions between September 2008 and June 2010 in Spain, a total of individual 441 
short positions were reported and published, from 56 entities (mostly hedge funds), 
with  an  average  position  disclosed  of  0.46%  of  the  share  capital  of  the  issuer.  The 
Spanish  regulator  also  provided  data  estimating  the  level  of  naked  short  selling  in 
their  jurisdiction  based  on  failed  transaction  statistics.  When  considering  these 
figures it has to be noted that Spain has a permanent ban on naked short selling, so 
these  cases  represent  occurrences  of  naked short  selling  despite  the  ban,  and  at  the 
height  of  the  crisis  the  Spanish  regulator  reminded  market  participants  of  their 
obligations  in  this  regard29.  According  to  their  estimates,  naked  short  selling 
represented  0.04%  of  all  trades  in  2009,  down  from  0.11  in  2007  (or  0.08%  of 
trading volume in 2009, down from 0.30% in 2007).30  

Greece  is  the  only  EU  Member  State  which  has  a  requirement  for  short  sale 
transactions  on  its  market  to  be  flagged,  and  the  Greek  regulator  is  therefore  in 
possession of data showing the actual volume and value of short sale transactions on 
its market. According to data for January to June 2010, the volume of short selling 
transactions as a percentage of total transactions is in a range between 0 and 3.33%. 
In terms of value the range is between 0 and 3.36%.31 

To  conclude,  it  is  difficult  to  obtain  reliable  data  on  the  extent  of  short  selling  in 
Europe  in  the  absence  of  marking  of  transactions,  or  of  disclosure  of  short  selling 

28 

29 

30 

31 

Response  by  the  UK  FSA  to  Commission  services  questionnaire  on  short  selling  and  Credit  Default 
Swaps.  
"Agreement of the Executive Committee of the CNMV on naked short selling, adopted on September 
22nd 2008". http://www.cnmv.es/Portal/verDoc.axd?t={0f1fd720-9592-45fc-b293-4fc99e82ce4f} 
Response  by  the  Spanish  CNMV  to  Commission  services  questionnaire  on  short  selling  and  Credit 
Default Swaps.  
Response  by  the  Greek  HCMC  to  Commission  services  questionnaire  on  short  selling  and  Credit 
Default Swaps.  

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transactions. However, according to the data outlined above it could be estimated to 
represent  between  1  and  3%  of  market  capitalisation  using  securities  lending  as  a 
proxy, or less than 1% of the total share capital of the issuer using data on disclosures 
of net short positions in the UK and Spain as a measure. It is difficult to estimate the 
volume  of  naked  short  selling  in  the  absence  of  data  from  countries  where  this 
practice  is  permitted,  but  the  data  from  Spain  suggests  that  this  is  a  fraction  of  the 
total volume of short selling. However, while the volume of short selling in Europe 
appears on this evidence to be limited, concerns remain about the risks short selling 
can  pose,  especially  in  distressed  markets,  and  these  are  explored  further  in  the 
problem definition below. 

Short selling in credit instruments 

Credit  instruments  include  both  corporate  and  sovereign  bonds.  In  principle  it  is 
possible to sell corporate bonds short, but the liquidity of the corporate bonds market 
is  limited  as  there  is  no  active  secondary  market  for  a  large  part  of  the  bonds 
outstanding.  Several  factors  explain  this:  each  issuer  tends  to  have  different  issues 
outstanding,  so  secondary  market  activity  is  fragmented  into  these  different  issues; 
and the maturity of corporate bonds is limited compared to equities where there is no 
repayment schedule, and investors on corporate bond markets tend to buy and hold 
for the long term. Therefore, most of the short selling activities on corporate bonds 
take  place  through  the  CDS  market,  where  the  liquidity  is  much  higher.  Regarding 
sovereign bonds, this market presents higher liquidity then the corporate bond market 
as  there  tend  to  be  fewer  issues  per  issuer  and  each  issue  is  of  a  larger  size.  In 
addition,  the  sovereign  CDS  market  is  less  liquid  then  the  corporate  CDS  market. 
Short  selling  a  bond  could  therefore  be  considered  easier  and  a  short  seller  would 
face a more balanced choice between using the bonds or the CDS.  

Short selling in interest rate instruments 

This market consists mostly of derivatives. There is no real short selling of interest 
rate derivatives as any derivative contract does not pre exist the operation, it is only 
created  when  bought  or  sold;  in  other  terms,  there  is  no  secondary  market.  Interest 
rate  derivatives  are  very  global  instruments,  and  they  are  used  by  a  wide  range  of 
participants  for  risk  management  purposes  and  through  often  complex  strategies. 
There is no evidence of concerns related to short selling on this market. 

Short selling currencies 

Currency  markets  are  open  24  hours  a  day,  7  days  a  week,  and  may  be  the  most 
global market of all asset classes. Short selling does occur on this market and there is 
evidence  of  it  being  used  in  the  past  to  drive  down  the  price  of  a  currency  (most 
notoriously the speculation against the pound sterling by George Soros in the context 
of  the  instability  in  the  Exchange  Rate  Mechanism  in  1992;  there  have  also  been 
concerns  expressed  by  some  Member  States  in  February-March  2010  about  the 
possible  role  of  short  selling  of  the  euro  in  the  decline  of  the  currency's  value32). 
Nevertheless,  short  selling  regulation  has  been  very  seldom  used  worldwide  in  the 
foreign exchange market, and when applied, it has only been done by a few emerging 
countries.  

32 

Financial Times, Lagarde wants look into murky market, 14 February 2010. 

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Short selling commodities 

Strictly speaking, short selling of the underlying physical commodity is not an issue 
for  financial  regulation.  Selling  physical  commodities  short  in  anticipation  of  their 
price decreasing, which would then be bought back at the lower price, may occur but 
this  is  probably  dampened  by  the  costs  of  storing/producing  the  goods,  and  is  an 
option  mainly  for  commodity  companies.  Whether  this  practice  is  harmful,  for 
example  for  consumers,  is  an  issue  for  sectoral  (e.g.  energy)  legislation  rather  than 
financial regulation.  

Entering  into  equivalent  short  positions  through  commodity  derivatives  is  possible, 
but  attempting  to  disassociate  this  from  legitimate  hedging  and  price  discovery  is 
very difficult. This would also apply to short positions entered into either in the spot 
or derivative market as part of arbitrage strategies, and putting controls on this could 
have a negative impact on price convergence. In addition, any controls would require 
a highly differentiated approach according to each specific commodity market. Many 
commodity markets are global (e.g. crude oil, metals) and trading could easily shift 
to  other  jurisdictions,  and  continue  to  set  prices  for  Europe.  Furthermore,  sector-
specific legislative proposals to enhance transparency and market integrity in certain 
commodities  markets  is  under  preparation,  notably  for  gas  and  electricity  and  for 
emissions allowances. 

3.1.2 

Trades in Credit Default Swaps 

Credit Default Swaps (CDS) are financial derivatives. Derivatives are referenced on 
an underlying, which in the case of CDS is the credit risk of an issuer. The credit risk 
of an issuer is the risk of default of that issuer on its obligations towards its creditors. 
CDS transfer credit risk from one party to another.  

It is easiest to understand a CDS contract by comparing it with a bond. In a typical 
bond, the issuer agrees to pay the investor a regular sum, the coupon, in exchange for 
the principal amount, the issued amount. The investor is exposed to credit risk, as the 
borrower  may  not  return  the  principal:  therefore  buying  a  bond  implies  taking  a 
position  on  the  credit  risk  of  the  issuer.  A  similar  economic  effect  can  also  be 
achieved  by  selling  a  credit  default  swap,  but  here  no  principal  changes  hands  ex 
ante.  In  a  CDS,  the  seller  receives  regular  payments  from  the  buyer,  while  his 
obligation materialises only in event of default, when he has to provide for the credit 
loss. 

At  the  end  of  May  2010,  the  gross  notional  amount  of  the  total  CDS  market  was 
USD 14.5 trillion, with about 2.1 million contracts outstanding. The sovereign CDS 
market, which includes both sovereign indices and sovereign single names, reached 
USD 2.2 trillion, with about 0.2 million contracts outstanding. The outstanding gross 
notional  amount  of  the  Itraxx  Sovereign  Index  Western  Europe  was  USD  140  bn 
(and USD 10 bn in net terms)33. 

33 

See Depositary Trust and Clearing Company (DTCC) data 

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There are four main groups of market participants in the CDS market: dealers, non-
dealer  banks,  hedge  funds  and  asset  managers.  The  dealers  are  by  far  the  largest 
players on the market.34 

The  aims  of  these  market  participants  are  diverse  and  they  employ  different 
strategies: CDS can be used for hedging, arbitrage or speculative purposes. Examples 
of the reasons for buying or selling CDS are provided in the box below. 

Reasons for trading CDS  

Hedging: CDS can be used to neutralise or reduce a risk to which the CDS buyer is exposed from 
another position. An example of such an "insurable interest" would be a bondholder's exposure to 
the credit risk of the issuer of the bond; by buying a CDS he can reduce that risk by passing it on to 
the  CDS  seller.  The  bondholder  has  hedged  his  position  with  a  CDS.  Sometimes  the  buyer  of  a 
CDS is seeking to hedge a risk other than the credit risk of the bond issuer, for example the credit 
risk of a bank heavily exposed to the bond issuer. 

Arbitrage:  arbitrage  is  usually  understood  as  the  risk-free  exploitation  of  price  differences  in 
connected markets. The typical arbitrage operation that involves CDS is the combination of buying 
a CDS and entering into an asset swap where the fixed coupon payments of a bond are swapped 
against a stream of variable payments. It is known in the market as a trade on the basis. 

Speculation: CDS can also be used to take a position in order to exploit price changes by trading 
in and out. For example, a CDS seller has taken on risk (in exchange for the regular payments he 
receives from the CDS buyer); he will gain from the contract if the credit risk does not materialise 
during the contract's term or if the compensation received will exceed a potential payout. If a CDS 
buyer does not hold an underlying insurable interest (known as 'naked CDS'), he is also taking a 
position:  he  would  gain  from  the  contract  when  the  payout  he  receives  from  a  possible  default 
event exceeds the premiums he has paid, or when the market value of the CDS has increased above 
the acquisition price; such increase would reflect a perception by the market that the risk of default 
has raised. 

3.1.3 

Economic benefits of short selling and CDS 

There are many studies on the economic effects of short selling of shares, and most 
conclude that it has a number of general benefits to the market (a bibliography of the 
economic literature on short selling is included in annex 5).  

First, it significantly increases market liquidity in a security, as short sellers can sell a 
security  without  owning  it35.  Liquidity  is  important  for  a  market  as  it  makes  the 
completion of trades more likely, and larger trading volumes reduce transaction costs 
and  tend  to  increase  efficiency36.  According  to  a  study  by  the  consultancy  Oliver 

34 

35 

36 

Information provided by regulators and market participants to the Commission services at a meeting on 
CDS issues, 5 March 2010. 
Beber, Alessandro and Pagano, Marco, Short-Selling Bans around the World: Evidence from the 2007-
09 Crisis, CSEF working paper, examines the effect of short selling bans on liquidity by using bid-ask 
spreads as a measure of liquidity. The paper states, p 21: "Italy emerges as the country where the ban on 
short  sales  was  associated  with  the  most  dramatic  deterioration  of  market  liquidity,  followed  by 
Denmark, Australia and Norway. The U.S., U.K. and Ireland are in an intermediate group, while in the 
remaining countries short-selling bans have been associated with comparatively mild increases in bid-
ask spreads – in the order of about 50 basis points or less." 
Gruenewald,  Seraina;  Wagner,  Alexander;  and  Weber,  Rolf,  Short  Selling  Regulation  after  the 
Financial Crisis – First Principles Revisited, Working Paper, University of Zurich, 2009, p. 16. 

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Wyman, "as relatively substantial participants in equity markets, short sellers play an 
integral  role  in  providing  liquidity  and  maintaining  market  efficiency.  When  short 
sellers'  level  of  participation  decreases,  market  become  less  liquid,  more  expensive 
and  more  difficult  to  trade."  37  It  is  important  to  note  that  short  selling  typically 
involves not only the sale of the security concerned but also at a subsequent point the 
purchase of a similar quantity of the security to cover the short sale (so extra liquidity 
is provided from both sets of transactions). 

Second, it can act as a balance to irrational overpricing of securities and can mitigate 
price  bubbles  by  allowing  investors  to  act  where  they  believe  that  a  security  is 
overvalued38.  

Third, it leads to more efficient price discovery as it prevents prices from reflecting 
only  the  views  of  the  most  optimistic  investors  in  the  market  and  leads  to  faster 
integration  of  information  into  the  price  of  securities39.  A  review  of  the  economic 
literature  by  the  FSA  concludes  that  "in  summary,  the  empirical  literature  tends  to 
confirm,  with  some  qualifications,  the  theoretical  proposition  that  short  selling 
allows  negative  expectations  about  share  price  developments  to  feed  more  directly 
into the actual share price and thus contributes to efficient pricing."40 

Also, covered short selling requires the lending of securities to the seller to cover the 
settlement  of  the  short  sale.  Securities  lending  by  institutions  such  as  banks, 
insurance companies and pension funds generates additional significant revenue for 
longer term holders of securities.  

Academic  studies  also  acknowledge  that  introducing  derivative  securities  increases 
the  investment  opportunities  for  investors,  which  in  turn  could  make  markets  more 
efficient,  lead  to  positive  welfare  effects,  and  make  the  derivatives  market  interact 
with the  underlying securities market.  For example, CDS allow market participants 
to hedge their positions or express specific views on pure credit risk. In general, CDS 
markets  are  considered  more  liquid  than  bond  markets,  as  they  are  more 
standardised.  For  example  all  sovereign  CDS  on  Greece  have  a  unique  reference 
which is the credit risk of Greece. On the contrary, the bonds issued by Greece will 
split into different issues with different specificities, that will co-exist on the market. 
These  different  bonds  will  not  be  completely  interchangeable,  at  least  not  to  the 
extent  that  CDS  would  be.  The  higher  liquidity  of  the  CDS  market  allows  market 
participants to express their views more easily. This is especially the case with regard 
to taking a short position in an entity, which is easier to do on the CDS market than 
using bonds. On the bond market investors have to rely on a functioning repo market 
in order to borrow the bonds necessary for short selling. In several countries, the repo 
market  is  not  very  deep  and  therefore  is  less  functional.  In  addition,  the  required 
outlay  to  enter  into  a  short  position  on  the  CDS  market  is  much  less  than  its 

37 
38 

39 

40 

Oliver Wyman, The effects of short-selling public disclosure regimes on equity markets, 2010, p. 29. 
Battalio,  Robert  and  Schultz,  Paul,  Regulatory  uncertainty  and  market  liquidity:  the  2008  short  sale 
ban's impact on equity option markets, University of Notre Dame, 2010, p. 9 cite Ofek and Richardson 
(2003) as suggesting "that the inability to short led to high prices for internet stocks in 1999 and 2000, 
and the relaxation of constraints on borrowing shares for shorting led to the eventual collapse of prices 
for these stocks". 
Bris,  A.,  Goetzmann,W.  N.,  Zhu,  N.,  Efficiency  and  the  Bear:  Short  Sales  and  Markets  Around  the 
World, 2007, Journal of Finance, Vol 62, No 3, p. 28. 
FSA, DP09/1 (February 2009), Annex 1 p. 3. 

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equivalent  on  the  cash  market.  This  is  due  to  the  built  in  leverage  effect  of 
derivatives. 

While short selling and CDS transactions have benefits, there are also risks and these 
are analysed further below. 

3.1.4 

Stakeholders concerned by short selling and CDS transactions 

In  addition  to  the  financial  institutions  or  investors  who  engage  in  short  selling  or 
CDS  transactions  for  the  reasons  explained  above,  many  other  stakeholders  can  be 
affected by such transactions, notably:  

–  issuers, who wish to maintain shareholder value and therefore may fear that their 

share price may be affected negatively41;  

–  financial  institutions,  who  in  an  extreme  case  may  face  the  risk  of  bank  runs  if 

short selling amplifies a fall in their share price in a disorderly way42; 

–  individual investors, who may suffer from information asymmetry if they do not 
know the extent to which the price of a security is being affected by short selling 
and  whether  short  sellers  will  need  to  later  buy  back  the  shares  they  have  sold 
short43; 

–  regulators, who have an interest in knowing whether short positions are building 
up  which  could  pose  a  systemic  risk  or  whether  short  selling  is  being  used 
abusively44; 

–  governments,  as  issuers  of  bonds,  who  may  fear  a  negative impact  on  sovereign 
bond  spreads  and  the  cost  of  raising  funds  as  a  result  of  short  selling  of 
government bonds in the cash market or through the use of bonds derivatives and 
CDS45. 

3.1.5  Overview of current regulatory landscape and how it may evolve 

As outlined in the introduction and detailed in annex 3, EU Member State regulators 
adopted  divergent  approaches  to  the  regulation  of  short  selling  in  autumn  2008, 
ranging  from  temporary  bans  on  short  selling  of  financial  stocks  to  partial  bans  on 
naked  short  selling  and  to  no  action  at  all46.  As  explained  in  section  3.4,  some 

41 

42 
43 
44 
45 

46 

“Short  Selling  Study:  The  Views  of  Corporate  Issuers”,  Opinion  Research  Corporation,  October  17, 
2008.  In  this  survey  of  CEOs  of  NYSE  and  NASDAQ  listed  issuers,  almost  60%  of  respondents 
consider  short  selling  to  be  harmful  to  their  company’s  stock  and  to  their  shareholders,  and  75%  of 
respondents think that short selling should be prohibited in periods of heightened volatility. 
FSA DP09/1, February 2009, p. 12. 
Ibid, p. 13. 
Source: responses provided by regulators to a questionnaire by the Commission services. 
Joint  letter  dated  10  March  2010  to  President  Barroso  and  Prime  Minister  Zapatero,  from  President 
Sarkozy, Chancellor Merkel, Prime Minister Juncker and Prime Minister Papandreou. 
Some  Member  States  adopted  temporary  emergency  measures  banning  short  selling  in  financial 
institutions (e.g. Austria, Denmark, France, Germany, Ireland, Italy, Netherlands, UK), whereas others 
(e.g. Finland, Sweden) adopted no rules on short selling at all in response to the crisis. Of the Member 
States  which  banned  short  selling  in  financial  institutions temporarily  in  2008, Austria,  Denmark  and 
France still have those bans in place today. Furthermore, some Member States banned only naked short 

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Member  States  subsequently  introduced  short  selling  disclosure  requirements  with 
thresholds varying from 0.01% to 0.25% of the total share capital of the issuer.  

Those  Member  States  that  introduced  temporary  measures  did  so  due  to  concerns 
that  short  selling  may  have  been  aggravating  the  downward  spiral  in  the  prices  of 
shares, notably in financial institutions, in a way which could pose risks to financial 
stability, orderly markets and market integrity47.  

In addition to the measures adopted by a number of Member States in autumn 2008, 
the Greek regulator introduced the flagging of short sale orders and an uptick rule on 
15 May 200948. The German regulator BaFin adopted on 18 May 2010 a temporary 
ban (until 31 March 2011) on CDS transactions where the reference liability is also a 
liability of a euro zone country and is not used to hedge default risks (i.e. a ban of 
'naked  CDS'  on  sovereign  debt);  the  ban  also  concerns  uncovered  short  selling  of 
debt  securities  of  eurozone  countries  admitted  to  trading  on  a  domestic  exchange, 
and a ban on uncovered short selling of shares in 10 financial institutions  49. On 28 
April 2010 the Greek Capital Markets Commission decided to temporarily ban short 
selling of shares listed in the Athens Exchange; this was lifted on 26 August 2010 but 
a ban on naked short selling was maintained50. 

On  2  June  2010,  the  German  Cabinet  of  Ministers  endorsed  a  draft  law  that 
essentially bans naked short-selling of all shares and government bonds traded on a 
German  regulated  market  including  correlated  derivatives  on  shares,  and  of  certain 
credit derivatives and currency derivatives that are entered into in Germany without 
having  a  relevant  hedging  function51.  On  10  June,  the  French  National  Assembly 
adopted  in  first  reading  a  draft  law  on  banking  and  financial  regulation  which 
reduces  the  settlement  period  for  short  selling  from  three  days  to  one52.  On  1  July 
2010,  new  rules  including  the  flagging  of  short  sale  orders  became  effective  in 
Poland53. 

At European level, national competent authorities discussed and agreed within CESR 
in  March  2010  a  two-tier  regime  for  the  disclosure  of  short  selling  transactions  to 

47 

48 
49 

50 

51 

52 

53 

selling  in  certain  financial  institutions  (Belgium,  Luxembourg,  Portugal)  or  in  all  issuers  (Greece), 
while another already had a ban on naked short selling in place (Spain).  
CESR report, Model for a Pan-European Short Selling Disclosure Regime, CESR/10-088, March 2010, 
p. 3. 
CMC rule 1/509/15.5.2009 
General  Decree  of  the  Federal  Financial  Supervisory  Authority  (BaFin)  on  the  prohibition  on 
contracting a credit derivative or entering into a transaction on the same if a no more than insignificant 
reduction  of  the  protection  buyer’s  risk  is  achieved  thereby,  of  18  May  2010;  General  Decree  of  the 
Federal  Financial  Supervisory  Authority  (BaFin)  on  the  prohibition  of  uncovered  short-selling 
transactions in debt securities of Member States of the EU whose legal currency is the euro, of 18 May 
2010;  General  Decree  of  the  Federal  Financial  Supervisory  Authority  (BaFin)  on  the  prohibition  of 
uncovered short-selling transactions in certain shares of 18 May 2010 
See guidance on HCMC's decision regarding short selling ban: 
http://www.hcmc.gr/photos/kefalaiagora/files/Guidance%20on%20Short%20Selling%20Ban_110510.p
df Lifting of ban – see press release: http://www.hcmc.gr/photos/nea/files/Short_Selling_260810.pdf  
Draft law on the Enhancement of Integrity of the Financial Markets, German Ministry of Finance, 25 
May 2010 
Projet  de  loi  adopté  par  l'Assemblée  Nationale,  de  régulation  bancaire  et  financière,  TA  no.  485,  10 
June 2010, chapter 5 article 7bis. 
See http://gss.unicreditgroup.eu/gss/pdf/Poland/Newsflashes/PL20100526_016.pdf and 
http://www.gpw.pl/zrodla/papierywartosciowe/krotka/pdf/rules-ks.pdf  

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regulators and the public54. CESR has recommended that those CESR members that 
already  have  the  necessary  powers  at  national  level  should  begin  to  implement  the 
model and that others should do so on a best endeavours basis. The report advocates 
a  two-tier  model  for  disclosure  of  significant  individual  net  short  positions  in  all 
shares  that  are  admitted  to  trading  on  an  EEA  regulated  market  and/or  an  EEA 
multilateral trading facility (MTF). At the lower threshold of 0.2%, positions would 
be disclosed to the relevant regulator, at the higher threshold of 0.5% positions would 
be disclosed, in addition to the regulator, also to the market as a whole. 

At EU level, when short selling is carried out in connection with abusive strategies, 
such  as  the  spreading  of  false  rumours  in  order  to  drive  down  share  prices,  it  is 
prohibited by the Market Abuse Directive (MAD)55. However, there is currently no 
overarching  EU  legislative  framework  dealing  with  other  risks  that  can  arise  from 
short selling.  

With regard to the regulation of the CDS market, which is an over the counter (OTC) 
market operated by broker dealers, these brokers dealers need to be authorized under 
the  requirements  of  article  5  of  the  Directive  on  Markets  in  Financial  Instruments 
(MiFID)56. These firms are also subject to the operations conditions laid out in this 
same  Directive  (articles  under  Chapter  II).  Nevertheless,  the  participants  in  these 
markets  are  considered  professional  clients  or  eligible  counterparties  in  the  MiFID 
terminology  (see  article  24  and  Annex  II  of  the  Directive).  Therefore,  they  do  not 
benefit from the same level of protection as of retail investors. Furthermore, the CDS 
market is not operated on regulated markets or MTFs and is not subject to the same 
transparency  or  reporting  rules.  Only  a  few  countries  have  decided  to  extend  the 
reporting obligations (UK, Spain), options which are defined in Recitals 45 and 46 of 
the MiFID Directive, to the CDS market. 

Regulatory developments on short selling in the USA 

Other  regulatory  developments  which  are  relevant  in  this  context  have  occurred  in 
the  United  States  in  recent  years  (a  more  detailed  overview  and  explanation  of  the 
US  measures  is  provided  in  annex  6).  The  United  States  operated  an  'uptick  rule' 
from 1937 until its abolition by the Securities and Exchange Commission (SEC) in 
2007.  In  2004,  the  SEC  adopted  Regulation  SHO57  which  introduced  a  number  of 
additional  requirements  for  short  selling:  a  'locate'  rule  for  short  sellers,  a  flagging 
regime and a "close-out" requirement for short positions. On 24 February 2010 the 
SEC  adopted  the  "revised  uptick"  or  "circuit  breaker"  rule.  This  rule  restricts  short 
sales  of  a  share  whose  price  has  fallen  by  more  than  10%  compared  to  its  closing 
price the previous day58.  

54 
55 

56 

57 

58 

CESR, March 2010. 
Directive  2003/6/EC  of  the  European  Parliament  and  of  the  Council  of  28  January  2003  on  insider 
dealing and market manipulation (market abuse), L 96/20, 12.04.2003, articles 1.2 and 5. 
Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in 
financial instruments, OJ L145, 30.04.2004. 
Regulation  SHO,  Securities  and  Exchange  Commission,  17  CFR  PARTS  240,  241  and  242  [Release 
No. 34-50103; File No. S7-23-03] http://www.sec.gov/rules/final/34-50103.htm#P19_2741  
The  SEC's  New  Short  Sale  Rule:  Implications  and  Ambiguities,  Davis  Polk  Client  Memorandum, 
08.03.2010, p. 4.  

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During  the  financial  crisis,  the  SEC  introduced  a  number  of  temporary  emergency 
measures.  On  15  July  2008,  the  SEC  introduced  a  temporary  "pre-borrow" 
requirement  on  short  selling  of  shares  in  19  systemically  important  financial 
institutions59. On 18 September the SEC imposed a temporary ban on short sales of 
799 financial stocks60, which grew to 1000 issuers. In September 2008 the SEC also 
tightened the "close-out" requirement so that it applied to all securities not settled the 
day after the normal settlement date, and imposed temporary reporting requirements 
on  certain  short  sales  and  positions.61  Since  1  August  2009,  the  SEC  has  been 
working  with  self-regulatory  organisations  to  make  short  selling  volume  and 
transaction data available to the public through the latter's web sites. The Wall Street 
Reform Act enacted into law by the US President on 21 July 2010 includes certain 
provisions  on  short  selling,  notably  it  requires  the  SEC  to  adopt  rules  for  public 
disclosure, at least monthly; of the amount of short sales by institutional investment 
managers62.  

Regarding  CDS  and  especially  sovereign  CDS,  no  specific  measures  have  been 
adopted  by  the  US  authorities  for  the  time  being.  However,  CDS  fall  within  the 
scope of new US legislation on financial services just adopted by the US Congress, 
and the CFTC and SEC will be expected to produce joint rules to implement this.  

As this overview shows, the regulatory landscape is not static, either in the EU or the 
United  States.  In  light  of  the  recommendations  of  CESR  for  a  disclosure  regime, 
Member States may adopt national legislation to implement these recommendations, 
although some may prefer to wait until a European legislative initiative is proposed. 
CESR is also considering a possible regime for disclosure to regulators of significant 
net  short  positions  in  sovereign  bonds.  These  net  short  positions  would  take  into 
consideration  short  positions  obtained  through  bonds  and  credit  derivatives, 
including  CDS  transactions  on  sovereign  bonds.  Finally,  as  explained  above  there 
has  been  a  strong  call  for  EU  legislative  action  by  some  heads  of  state  and 
government. 

3.2. 

Problem definition 

This  section  examines  the  main  risks  associated  with  short  selling  in  the  European 
Union  and  the  problems  they  give  rise  to.  These  risks  and  problems  can  be 
summarised  as  follows:  (i)  risks  of  negative  price  spirals,  which  can  result  in 
disorderly  markets  and  possible  systemic  risks;  (ii)  risks  of  settlement  failure  that 
may  be  associated  with  naked  short  selling;  (iii)  accompanying  these  risks  is  the 
problem  of  transparency  deficiencies  on  short  selling  transactions  which  prevent 
markets  and  regulators  from  effectively  preventing  potential  negative  impacts  of 
short selling, resulting in risks to financial stability, market integrity and information 
asymmetries between market participants. Finally several Member States have taken, 

59 

60 

61 
62 

SEC Release 34-58166, Emergency Order Pursuant to Section 12(k)(2) of The Securities Act of 1934 
Taking  Temporary  Action  to  Respond  to  Market  Developments,  July  15,  2008.  Available  at: 
http://www.sec.gov/rules/other/2008/34-58166.pdf. 
SEC,  Emergency  Order  Pursuant  to  Section  12(k)(2)  of  the  Securities  Exchange  Act  of  1934  Taking 
Temporary  Action  to  Respond  to  Market  Developments.  Release  34-58572.  September  17,  2008. 
Available at: http://www.sec.gov/rules/other/2008/34-58572.pdf. 
The D.E. Shaw Group Market Insights, May 2010, p. 6. 
Davis  Polk,  Summary  of  the  Dodd-Frank  Wall  Street  Reform  and  Consumer  Protection  Act,  Enacted 
into Law on July 21 2010, 21 July 2010, p. 70. 

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or are likely to take in future, action to address the above risks and problems, but in 
an  uncoordinated  manner.  This  fragmented  regulatory  framework  then  leads  to  the 
most  important  problem,  that  of  (iv)  increased  compliance  costs  for  firms  and 
potential regulatory arbitrage. 

The following problem tree provides an overview of the various problems and risks 
that arise in the context of short selling. The issues are displayed in the problem tree 
in  order  of  their  importance,  starting  with  the  most  important  problem,  regulatory 
fragmentation.  

A  detailed  explanation  will  follow  in  the  section  below,  which  begins  with  the 
explanations of the risks of negative price spirals and settlement risks, followed by 
the problems of transparency deficiencies and regulatory fragmentation.  

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Drivers 

Risks/Problems 

Consequences 

3.2.1.  Other related issues outside of the scope of this initiative  

In addition to the problems outlined above and described in the problem definition, 
there are a number of other risks and problems which are related to short selling and 
CDS which will be addressed in other pending initiatives: 

–  Mitigation  of  counterparty  credit  risk  of  CDS  transactions:  the  options  aimed  at 
reducing  counterparty  credit  risk  (either  through  bilateral  or  central  clearing)  in 
the OTC derivatives market, including the CDS market segment, are examined in 
the  impact  assessment  for  the  legislative  proposal  on  derivatives  and  post-trade 
market infrastructures, due by the end of the summer, as this is an issue which is 
of  concern  for  all  derivatives  and  is  therefore  best  addressed  in  a  horizontal 
instrument; 

–  Lack  of  transparency  on  CDS  positions:  the  options  aimed  at  increasing  the 
transparency  of  OTC  derivatives  positions,  including  CDS  positions,  are  also 
considered  in  the  impact  assessment  on  derivatives  and  post-trade  market 
infrastructures as this is a horizontal issue for all derivatives; 

EN 

22 

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–  Transparency  deficiencies  for  regulators  on  all  financial  transactions:  currently, 
only transactions on regulated markets are required to be reported63, whereas OTC 
transactions  are  not.  The  option  to  require  reporting  to  regulators  of  all 
transactions,  including  OTC  transactions,  in  all  instruments,  not  just  significant 
net short positions, will be examined in the impact assessment for the revision of 
the Directive on Markets in Financial Instruments (MiFID), due by the beginning 
of 2011, as it would provide regulators with an additional tool to detect possible 
systemic risks and risks to market integrity; 

–  Transparency  deficiencies  for  regulators  concerning  all  financial  positions:  the 
option to require the reporting of all significant financial positions, whether long 
or short, and the possibility of setting limits for such positions, will be assessed in 
the  impact  assessment  for  the  MiFID  review,  as  this  option  could  provide 
regulators  with  a  tool  to  prevent  market  participants  from  creating  disorderly 
markets through excessively large positions and to detect possible systemic risks; 

–  Market  manipulation  through  OTC  derivatives:  the  option  to  extend  the 
prohibition of  market manipulation to all OTC instruments  including derivatives 
which  could  impact  the  prices  of  financial  instruments  traded  on  a  regulated 
market or MTF will be considered in the impact assessment for the review of the 
Market  Abuse  Directive,  due  by  the  end  of  the  year.  This  option  would 
complement  this  initiative  by  providing  regulators  with  the  tools  to  sanction 
possible market manipulation of underlying bond markets through CDS. 

As  the  above  problems  and  the  possible  options  to  tackle  them  are  horizontal  in 
nature, for reasons of efficiency and better regulation they are best tackled in other 
initiatives,  which  are  all  subject  to  impact  assessment,  and  are  therefore  excluded 
from the scope of this impact assessment.  

In addition, the Council and the European Parliament are discussing in the context of 
discussions  on  the  ESMA  Regulation64  the  possibility  of  ESMA  having  the  task  to 
temporarily  prohibit  or  restrict  certain  types  of  financial  activities  that  threaten  the 
orderly functioning and integrity of financial markets or the stability of the financial 
system  under  the  conditions  set  out  in  specific  legislative  acts  or  in  an  emergency 
situation. The possibility of prohibiting some products could also be discussed within 
the revision of MiFID. 

Finally,  the  European  Parliament  has  proposed  amendments  to  the  proposal  for  a 
Directive  on  AIFM  which  would  regulate  short  selling  and  naked  short  selling. 
However,  the  Commission  considers  that  these  issues  are  best  addressed  in  a 
horizontal initiative aimed at all investors who engage in short selling, rather than an 
instrument  aimed  only  at  alternative  investment  fund  managers,  since  all  investors 
can potentially engage in short selling and legislation only addressed at one category 
of investors would leave regulatory gaps. 

63 
64 

Article 25 of the Directive on Markets in Financial Instruments.  
COM(2009) 503 final, 23.9.2009. 

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3.3. 

Problem 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 markets 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'),  which  can 
lead to excessive downward pressure on the price of securities. The risk of negative 
price spirals becoming self-fulfilling, which can lead to disorderly markets and even 
systemic  risks,  is  the  main  concern  expressed  by  regulators  with  regard  to  short 
selling65. 

The risk of short selling of shares in financial institutions amplifying negative price 
spirals and leading to systemic risks (through a 'contagion effect') can be explained 
with  reference  to  the  financial  crisis.  While  fundamentals  and  lack  of  investor 
confidence  rather  than  short  selling  were  arguably  the  major  contributors  to  the 
underlying market volatility, a number of EU regulators and other regulators around 
the world introduced emergency bans on short selling of financial stocks in autumn 
2008 due to concerns that excessive short selling could amplify the decline in prices, 
which  could  become  a  self-fulfilling  downward  price  spiral  and  ultimately  lead 
financial  institutions  into  financial  difficulties  through  bank  runs  and  have  a 
'contagion effect'66on other institutions. 

It is important to note that short selling on cash markets is not the only way for an 
investor to secure a short position; this can also be achieved by the use of derivative 
transactions  such  as  options  or  contracts  for  difference67.  CDS  can  also  be  used  to 
secure  an  economic  short  position.  Buying  a  CDS  without  holding  an  underlying 
insurable interest ('naked CDS') is economically equivalent to short selling a bond, as 
the naked buyer benefits if the price of the CDS goes up. The CDS price will go up if 
the  risk  of  default  increases,  or  at  least  the  perception  of  the  risk  of  default  by  the 
market increases. Any perceived increase in the risk of default of a bond issuer will 
result in increased spreads and increased interest rates on the bonds, hence a decrease 
in the price of the bonds. So, the buyer of the naked CDS benefits from an evolution 
of price which is symmetrical to the one benefiting the person short selling the bond. 

A specific problem which has been raised by several governments and regulators in 
Europe68  with  regard  to  CDS  concerns  the  interaction  between  CDS  and  bond 
markets,  and  the  fear  that  this  interaction  could  cause  mispricing  on  bond  markets 
and  thus  higher  funding  costs  for  governments.  As  CDS  contracts  tend  to  be  more 
liquid  than  the  underlying  bonds,  and  are  often  used  by  investors  who  are  more 
reactive  in  their  investments  than  bondholders,  CDS  are  sometimes  considered  as 
likely to integrate new information faster than the bonds.  

Furthermore, as the investors using CDS are also more mobile than traditional bonds 
investors,  CDS  prices  can  be  more  volatile  than  bonds  prices.  Because  of  the 
arbitrage  relationship  mentioned  before,  CDS  and  bonds  prices  are  interconnected. 

65 
66 
67 
68 

Discussion Paper 09/1, Short Selling, February 2009, p. 3, UK Financial Services Authority. 
Ibid, p. 12. 
FSA DP09/1, February 2009, p. 7. 
Cf Letter from France, Germany, Greece and Luxembourg to Mr Barroso dated 10 March 2010 

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Nevertheless, this interconnection is complex. Furthermore, the structure of the CDS 
market tends to be concentrated.69 This concentration could contribute to higher short 
term volatility in CDS prices. For example, a sudden rise in the demand for CDS to 
hedge  either  pure  sovereign  risk  or  more  general  macroeconomic  risks,  or  even  to 
speculate on that market, may unleash disproportionate effects on the CDS prices if 
their supply cannot react swiftly enough in the short run. If market participants base 
their expectations concerning bond prices on CDS behaviour, this may contribute to 
a  very  fast  decline  of  prices  on  the  cash  bond  market,  which  may  lead  to  self 
fulfilling  expectations.  Traditional  bonds  investors  may  take  fright  at  the  drop  in 
value  of  their  investments  caused  by  the  contagion  of  the  CDS  market  and  start 
disinvesting.  The  disposal  of  their  bond  positions  by  long  term  investors  could 
accelerate the fall of the bond market. 

Furthermore,  because  of  its  mechanisms,  the  CDS  presents  the  danger  of  self-
fulfilling effects that can open risks of moral hazard. If market participants buy CDS 
without holding a proportionate insurable interest in the underlying debt obligation or 
exposure to the underlying credit risk, it can be argued that such a possibility gives 
the  holder  of  the  CDS  a  perverse  incentive  to  precipitate  a  default  and  therefore 
obtain the payout foreseen by the CDS. However, as it is difficult for a CDS buyer to 
achieve  such  an  outcome  directly,  the  mechanism  is  argued  to  be  more  indirect: 
creating strong demand for CDS drives up the credit risk premium, making it more 
expensive  to  issue  bonds  and  roll  over  debt,  which  can  create  capital  gains  for 
investors  with  short  positions  on  the  underlying  bonds;  pushed  to  its  extreme,  this 
could ultimately result in a default of the issuer. Nevertheless, such an action is likely 
to  be  very  difficult  to  achieve  regarding  sovereign  CDS  markets  as  they  only 
represent a tiny fraction of the underlying bond markets70. A price evolution on CDS 
that would be "too artificially" driven would be very short lived and counterbalanced 
by  the  price  evolution  on  the  bond  market.  The  difference  in  size  between  the 
sovereign CDS and bonds market is also likely to play a role in limiting the effects of 
a negative price spiral. 

There  are  other  risks  associated  with  CDS,  for  instance,  the  mechanism  of  the 
instrument itself: in case the entity covered by the CDS contract defaults, the seller of 
protection may have to disburse large amounts, and may not be in a position to meet 
these  payments.  This  creates  huge  counterparty  risks71.  However,  this  risk  is  not 
addressed here as it is covered in the impact assessment for the separate Commission 
initiative on market infrastructures72. 

In  summary,  the  responses  of  regulators  to  the  questionnaire  by  the  Commission 
services  revealed  that  many  of  them  have  concerns  about  the  risk  of  short  selling 
amplifying  price  falls  in  distressed  markets,  and  that  this  could  lead  to  bank  runs 
through  a  contagion  effect.  While  to  date  there  is  no  clear  empirical  evidence 
showing a causal link between short selling and negative price spirals, the concern of 

69 
70 

71 

72 

See European Central Bank report dated June 2009 on the sovereign CDS market 
At the end of May 2010, the outstanding of sovereign CDS stood at USD 2.2 trillion to be compared to 
an outstanding sovereign bond market of around USD 40 trillion (source: DTCC and BIS) 
See  Commission  Staff  working  paper  dated  20  October  2009  accompanying  Commission 
communication on a roadmap for ensuring, efficient, safe and sound derivatives markets 
See  Public  Consultation  on  Derivatives  and  Market  Infrastructures,  launched  on  14.06.2010: 
http://ec.europa.eu/internal_market/consultations/2010/derivatives_en.htm  

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regulators was sufficient to lead many of them to restrict or ban short selling during 
the  financial  crisis  as  a  precautionary  measure  and  most  regulators  have  expressed 
support  for  clear  powers  in  exceptional  situations  to  guard  against  this  risk  in  the 
future  (see  annex  4).  Further,  the  fact  that  Member  States  have  taken  divergent 
regulatory responses to this risk has led to a fragmented regulatory framework which 
leads  to  increased  compliance  costs  for  market  participants  and  potential  for 
regulatory arbitrage (see problem 4). 

3.4. 

Problem 2: Risk of settlement failure associated with naked short selling 

The risk of the short seller failing to deliver 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 selling73.  

Data on levels of settlement failure is very limited, but the data available from some 
Member  States  suggest  they  are  low  in  Europe.  According  to  the  data  provided  by 
one regulator, settlement failures represented 3.89% of all equity transactions cleared 
by  a  central  counterparty  (CCP)  in  2010,  compared  to  2.74%  in  2009.  In  another 
Member State settlement failures represented 2.71% of all transactions in 200974. In 
Spain (where naked short selling is banned), settlement failures occurred in 0.11% of 
all securities trades in 2007 and 2008 and in 0.04% of trades in 2009; for sovereign 
bonds settlement failures represented 0.22% of transactions in 2009 and 0.003% of 
corporate bonds in the same year75.  

When assessing the reasons for these settlement failures, the few regulators that were 
able to provide reasons cited administrative problems such as back-office mistakes, 
naked  short  selling  or  other  factors  such  as  the  delayed  transfer  of  funds  for 
payment76. The Spanish regulator carried out a study of settlement failures between 
January  and  December  2008  which  showed  that  59%  of  settlement  failures  came 
from  naked  short  selling  activity,  although  only  0.39%  of  the  total  settled  amount 
could be considered as settlement failure77.  

In terms of qualitative responses to the consultation of regulators carried out by DG 
Internal  Market78,  one  regulator  cited  several  cases of  "massive  naked  short  selling 
prior  to  capital  increases  which  resulted  in  failure  to  settle  on  settlement  day  and 
market  disturbances".  One  regulator sanctioned an intermediary in September 2008 
who  was  unable  to  deliver  securities  in  due  time  as  a  result  of  uncovered  short 
selling; they also identified a number of cases of suspected naked short selling end 
2008  but  had  difficulties  to  determine  the  liability  of  the  persons  involved.  On  the 
other hand, 14 regulators had no evidence or experience of naked short selling or of 
settlement  problems  occurring  as  a  result,  or  thought  that  the  risks  were  limited  or 
could  be  addressed  by  settlement  discipline.  While  the  UK  FSA  sees  "occasional 
cases of problems caused by naked short selling in the equity markets", they consider 

73 

74 
75 
76 
77 
78 

Source: responses by national regulators to questionnaire by the Commission services. Unless the origin 
of the data is clearly indicated, sources are anonymous at the request of the regulators concerned who 
wished their identity to remain confidential. 
Source: responses by national regulators to questionnaire by the Commission services. 
Source: data provided by Spain in response to a questionnaire by the Commission services. 
Source: responses by national regulators to questionnaire by the Commission services. 
Source: data provided by Spain in response to a questionnaire by the Commission services. 
Source: responses by national regulators to questionnaire by the Commission services. 

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"that the overall risks from naked short selling are minimal". According to the FSA's 
discussions  with  exchanges  and  market  participants,  "naked  short  selling  is  by  no 
means  a  principal  source  of  settlement  failures  –  more  common  are  administrative 
errors or the knock-on effects of problems elsewhere in the settlement chain"79  

In the US,  concerns about high levels of settlement failure linked with naked  short 
selling  led  the  SEC  to  introduce  an  emergency  order  on  15  July  2008,  imposing  a 
requirement on short sellers of specific financial stocks to borrow those shares before 
entering into a short sale. An analysis by the US Office of Economic Analysis looked 
at settlement failures for 19 stocks listed in the emergency order before and after the 
order  came  into  force,  and  found  "a  large  reduction  in  fails  to  deliver"  of  64%  in 
volume and 56% in value.80 

It should be recalled that the Directive on markets in financial instruments (MiFID) 
imposes  specific  obligations  on  market  operators  to  have  in  place  effective 
arrangements  to  ensure  transactions  can  be  settled81,  and  most  exchanges  and 
Member  States  have  rules  on  settlement  discipline.  The  Commission  services  are 
also  undertaking  separately  preparatory  work  for  a  horizontal  initiative  which  will 
address  settlement  discipline,  including  the  option  of  a  possible  harmonisation  of 
settlement period. 

At the same time, in their responses to the questionnaire by the Commission services 
or the public consultation, several regulators cited the risk of price volatility as being 
greater  with  naked  short  selling  than  covered  short  selling.  Some  regulators 
expressed  concern  that  in  extreme  cases  naked  short  selling  can  put  enormous 
pressure  on  share  prices,  which  can  in  turn  endanger  the  stability  of  the  financial 
system82. This is because naked short selling enables the seller to sell, in principle, an 
unlimited  number  of  shares  in  a  very  short  space  of  time  as  they  do  not  have  to 
ensure that their position is covered first by borrowing or locating shares to borrow.83 
One  regulator  cited  the  Porsche-Volkswagen  case  as  evidence  of  this,  when  the 
number of shares being sold exceeded by a significant margin the number available 
to  borrow  as  Porsche  had  secured  a  significant  holding  in  Volkswagen  through  the 
use of derivatives.84 

In  summary,  while  some  regulators  consider  the  risk  of  settlement  failure  to  be 
limited and consider that to the extent that any action should be taken to address risks 
of  naked  short  selling,  this  should  be  confined  to  enhanced  settlement  discipline, 
others  do  perceive  a  risk  of  settlement  failure,  as  well  as  a  risk  of  increased  price 

79 
80 

81 

82 
83 
84 

Source: response by the UK FSA to a questionnaire by the Commission services. 
Office of Economic Analysis, Analysis of the July Emergency Order Requiring a Pre-Borrow on Short 
Sales, 14 January 2009, pp. 12-13. According to the OEA study, "prior to the Order, the 19 issuers in 
the order sample had 2.8 million in fails valued at $64.2 million per day. With the order in effect, these 
19 issuers had 1 million in fails valued at $28.4 million per day, representing decreases of about 64% 
and 56% respectively. The number of securities with fails declined from 12 to 4.5 per day, representing 
a decline of about 63%. (…) In summary, we found that the Emergency Order led to a large reduction 
in fails to deliver and significantly reduced the frequency of new fails." 
Article  39  currently  requires  regulated  market  operators  to  have  effective  arrangements  in  place  to 
facilitate  the  efficient  and  timely  finalisation  of  transactions  executed  on  their  systems.  A  similar 
requirement for MTF operators can be found in MiFID article 14.5. 
Response by the German Federal Ministry of Finance to the public consultation, p. 5. 
Response by the AMF to the public consultation, p. 4. 
Confidential response by a regulator to the questionnaire by the Commission services. 

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volatility, arising from naked short selling which should be addressed as a matter of 
principle and as a precaution to guard against possible systemic and market integrity 
risks.  In  addition,  the  fact  that  Member  States  have  adopted  different  measures  in 
relation  to  the  risk  of  settlement  failure  and  naked  short  selling  fragments  the 
European regulatory framework, leading to higher compliance costs and potential for 
regulatory arbitrage (see problem 4 below). 

3.5. 

Problem 3: Transparency deficiencies  

In most EU Member States there are currently no disclosure requirements for short 
selling  or  CDS  transactions,  either  to  regulators  or  to  the  public,  so  these  Member 
States have no direct access to data on the short positions held in their jurisdictions; 
although  as  a  result  of  the  financial  crisis,  a  number  of  Member  States  have 
introduced different short selling disclosure requirements85. However, consensus was 
reached by all regulators within CESR to introduce a disclosure regime for net short 
positions  relating  to  EU  shares.  For  CDS,  the  Depositary  Trust  and  Clearing 
Company (DTCC) in the US operates a trade information warehouse that claims to 
collect  information  on  95%  of  the  trade  done  on  CDS  in  the  world.  Therefore 
regulators can obtain this data by requesting it from the DTCC. 

Regulators  have  expressed  concern  that  the  absence  of  information  about  short 
selling activity makes it difficult for them to detect the build-up of positions which 
could  have  implications  for  the  stability  of  markets.  Greater  transparency  through 
disclosure  to  the  regulator  could  help  regulators  to  identify  when  this  is  occurring, 
and  serve  as  a  deterrent  to  the  taking  of  aggressive  short  positions  which  could 
contribute to disorderly markets86. 

Another  difficulty  is  that  in  the  absence  of  transparency  requirements  for  short 
selling which cover short positions obtained through OTC transactions or derivative 
transactions,  regulators  would  not  have  a  complete  picture  of  which  market 
participants held a short position and any transparency requirements could easily be 
circumvented by a migration of sales off market or to derivatives87.  

The lack of information on short positions also means that regulators cannot properly 
monitor  short  selling  transactions  for  possible  market  abuse,  resulting  in  the 
possibility of abusive behaviour not being detected or sanctioned88. Although market 

85 

86 
87 

88 

See  table  in  annex  3.  Concerning  disclosure,  one  Member  State  required  daily  disclosure  of  all  short  selling 
transactions to the regulator (Greece, until 1.06.09), others require disclosure when a threshold of 0.25% of the total 
share  capital  of  certain  financial  stocks  is  breached  (Belgium,  France,  Ireland,  Spain  and  UK)  and  others  set  a 
different  threshold  (Hungary  –  0.01%,  Greece  –  0.10%  from  1.06.09).  The  remaining  Member  States  require  no 
disclosure of short selling transactions at all. Greece and Poland have rules in place requiring the flagging of short 
sale orders. 
FSA DP09/1, February 2009, pp. 24-25/ 
CESR/10-088,  March  2010,  p.  9  and  Regulation  of  Short  Selling  –  Consultation  report,  IOSCO 
Technical Committee, March 2009, p. 14. 
CESR report, Model for a Pan-European Short Selling Disclosure regime, CESR/10-088, March 2010, 
p.  5:  "CESR  considers  that  improving  the  transparency  of  short  selling  would  have  distinct  benefits 
which  would  outweigh  the  associated  costs.  It  would  help  deter  and  constrain  particularly  aggressive 
large-scale  short  selling  which  may  threaten  the  maintenance  of  orderly  markets  or  pose  the  risk  of 
market  abuse  and  provide  early  warning  signs  of  a  build-up  of  large  short  positions,  thereby  alerting 
regulators  to  potentially  abusive  behaviour  and  enabling  them  to  monitor  and  take  action  more 
effectively." 

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participants argue that most short selling is not abusive, and abusive short selling is 
already prohibited by the Market Abuse Directive, short selling can constitute market 
abuse in several ways: when it creates misleading signals about the real supply or the 
correct valuation of a share; when it is used in conjunction with the spreading of false 
rumours to drive down the price of the share being sold short; or when it is carried 
out on the basis of inside information89. According to some regulators, there may be 
a greater risk of market abuse associated with naked short selling90. There is concern 
also that financial institutions may be particularly vulnerable to abusive short selling, 
particularly at a time of severe market instability.91 

Concern  has  also  been  expressed  by  some  regulators  (in  five  Member  States)  that 
speculators  may  be  driving  down  the  prices  of  government  bonds  by  using  Credit 
Default  Swaps  (CDS)92.  The  concern  of  these  regulators  is  that  in  the  absence  of 
information  about  derivative  transactions  it  is  more  difficult  for  them  to  detect  the 
build-up  of  positions  which  could  cause  financial  instability,  as  well  as  possible 
market abuse. A similar comment can be made for sovereign bonds transactions. 

For  most  regulators  in  Europe,  the  ease  of  obtaining  access  to  data  on  derivatives 
varies according to the existence or not of a trade repository. In the case of CDS, the 
information  can  be  obtained  from  the  DTCC.  Some  regulators  (notably  in  the  UK 
and Spain) collect data on OTC derivatives through daily transaction reporting from 
market  participants  in  their  jurisdiction.  They  can  also  address  ad  hoc  requests  to 
market  participants  in  their  jurisdiction  or  via  the  CESR  Memorandum  of 
Understanding  for  other  markets.  However,  it  appears  from  the  contacts  that  the 
Commission has had recently with the DTCC that most regulators do not seem until 
now to have routinely requested transaction reports on CDS. This could be explained 
by the fact that regulators have only started looking at CDS issues recently and not 
yet established systematic procedures to use DTCC data. In addition, DTCC has only 
recently  increased  the  accessibility  to  its  data.  Finally,  the  information  stored  by 
DTCC deals with positions and not transactions. There is for instance no time stamp 
of transactions stored in the warehouse. 

Due  to  the  lack  of  disclosure  requirements,  there  is  also  a  risk  of  information 
asymmetries  between  informed  short  sellers  and  other  less  informed  market 
participants.  The  disclosure  of  significant  short  positions  to  the  market  provides 
information  to  other  market  participants  about  the  price  movements  which  short 
sellers  expect  and  this  could  improve  the  efficiency  of  price  discovery  if  correctly 

89 

90 

91 
92 

Khan,  Moffazar  and  Lu,  Hai,  Do  Short  Sellers  Front-Run  Insider  Sales?,  MIT  Working  paper,  find 
"significantly positive abnormal short sales in the days leading up to large insider sales, and peaking on 
the day of large insider sales" and they conclude that this "is consistent with front-running facilitated by 
leaked information". 
This risk of market abuse arises because the naked short seller is not constrained by the need to identify 
and borrow shares from the market before shorting them; this means that naked short sellers can sell as 
quickly as they can find buyers and can even sell more shares than the total  issued share capital of a 
company. Naked short selling can therefore more easily give a false impression of the supply of shares 
for sale since the seller does not have to borrow them before the sale; although it should be noted that 
naked  short  selling  without  any  intention  or  reasonable  plan  to  settle  the  short  position  might  be 
considered  to  be  market  abuse  that  is  already  prohibited  under  the  Market  Abuse  Directive.  For 
example, in one case in the UK, the competent authority took action against a party for market abuse for 
short selling 252% of the issued share capital of a company - See FSA DP09/1, p. 13. 
FSA DP09/1, February 2009, p. 11.  
Source: responses from national regulators to questionnaire by the Commission services. 

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interpreted.  Transparency  to  the  market  would  also  ensure  that  more  information 
about  the  opinions  that  investors  hold  on  a  particular  security  would  be  made 
available to all investors and issuers93. The disclosure of short selling information to 
the market also provides useful information as investors are then aware of the extent 
to which short selling is affecting the price of the security and also of the extent to 
which short sellers will later have to purchase a similar number of securities to cover 
their  short  sale  (again  bearing  in  mind  that  short  selling  typically  involves  two 
transactions  –  a  short  sale  and  a  subsequent  purchase  of  the  equivalent  number  of 
securities). 

In summary, there is clear evidence of a lack of transparency of data on significant 
short positions held by financial institutions, with fewer than half of Member States 
currently  applying  disclosure  regimes  and  only  one  Member  State  operating  a 
flagging regime. The current lack of transparency in relation to short selling data can 
also  be  seen  from  the  difficulty  in  obtaining  reliable  data  for  the  EU.  This  lack  of 
transparency  is  also  one  of  the  main  concerns  of  regulators  with  regard  to  short 
selling,  as  it  prevents  them  from  being  able  to  detect  at  an  early  stage  the 
development  of  positions  which  may  cause  risks  to  financial  stability  or  market 
integrity.  The  concern  of  regulators  is  so  great  that  they  have  already  agreed  on  a 
model  for  a  disclosure  regime  within  CESR.  Regulators  also  take  the  view  that 
disclosure to the public would deter aggressive short selling, which could reduce the 
risks  of  negative  price  spirals.  Issuers  would  welcome  the  disclosure  of  short 
positions  in  their  share  capital  as  it  enables  them  to  be  informed  about  the  market 
view  of  their  performance  and  prospects.  Finally,  the  fact  that  in  response  to 
concerns about lack of transparency, Member States have had different transparency 
rules in place and have not to date all implemented CESR's recommended approach 
to disclosure, results in a fragmented regulatory framework, and consequently higher 
compliance costs and potential for regulatory arbitrage (see problem 4 below). 

3.6. 

Problem  4:  Increased  compliance  costs  and  potential  regulatory  arbitrage 
arising from a fragmented regulatory framework  

The divergent responses of Member States to issues relating to short selling pose the 
risk of regulatory arbitrage, as investors could seek to circumvent restrictions in one 
jurisdiction  by  carrying  out  transactions  in  another.  This  regulatory  fragmentation 
will also lead to increased compliance costs for market participants, especially those 
operating  on  several  markets,  who  will  have  to  set  up  different  systems  to  comply 
with different requirements in different Member States.  

As  it  has  been  referred  to  above,  EU  Member  State  regulators  adopted  divergent 
approaches to the regulation of short selling in autumn 2008, ranging from temporary 
emergency  bans  on  short  selling  of  financial  stocks  to  partial  bans  on  naked  short 
selling  and  to  no  action  at  all.  Some  Member  States  adopted  temporary  emergency 
measures  restricting  or  banning  short  selling  in  financial  institutions  (e.g.  Austria, 
Denmark,  France,  Germany,  Ireland,  Italy,  Netherlands,  UK),  whereas  others  (e.g. 
Finland, Sweden) adopted no rules on short selling at all in response to the crisis. Of 
the  Member  States  which  restricted  or  banned  short  selling  in  financial  institutions 
temporarily  in  2008,  some  (e.g.  Austria,  Denmark  and  France)  still  have  those 

93 

FSA DP09/1 (February 2009), p. 24. 

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measures in place today. Furthermore, some Member States banned only naked short 
selling in certain financial institutions (e.g. Belgium, France, Luxembourg, Portugal) 
or in all issuers (Greece), while another already had a ban on naked short selling in 
place (Spain). Some Member States subsequently introduced short selling disclosure 
requirements with thresholds varying from 0.01% to 0.25% of the total share capital 
of the issuer and Greece and Poland introduced flagging regimes.  

Detailed  evidence  on  the  current  fragmented  regulatory  landscape  is  displayed  in 
Annex 3. 

In its consultation of regulators, DG Internal Market asked whether they perceived a 
risk  of  regulatory  arbitrage  arising  from  the  different  regulatory  responses  to  short 
selling in Europe. Of the respondents, six saw possible risks of regulatory arbitrage, 
6 did not feel this was a realistic prospect and one thought  it  would depend  on the 
circumstances. For one regulator, for the regulation of short selling to be effective it 
must  have  extra-territorial  reach  or  it  could  easily  be  circumvented  by  those 
undertaking short selling outside the jurisdiction94.  

As pointed out by one regulator in its response to a Commission questionnaire, if a 
company  is  listed  in  different  Member  States,  it  is  potentially  possible  to  take 
advantage of the different regulation concerning short selling, and the opportunities 
for regulatory arbitrage are greater for bonds, in particular sovereign bonds (although 
this may partly depend on the costs incurred in changing trading venues)95. Another 
example would be that if one Member State introduces a national ban on short selling 
in its financial institutions, investors might be tempted to short sell shares in financial 
institutions of a closely related neighbouring country as a proxy in order to continue 
to profit from the expected decline in financial shares96.  

This  regulatory  fragmentation  will  lead  to  increased  compliance  costs  for  market 
participants, especially those operating on several markets, who would have to set up 
different systems to comply with different requirements in different Member States.  

According  to  some  market  participants,  in  addition  to  increased  costs,  the  different 
national responses to short selling since September 2008 led to a significant increase 
in  legal  uncertainty  due  to  the  lack  of  harmonisation,  and  to  scope  for  regulatory 
arbitrage97.  

The  fragmented  approach  at  national  level  also  created  difficulties  and  costs  for 
market participants (many of whom operate businesses across Europe) in identifying 
and interpreting the different requirements, with the exemption of market makers in 

94 
95 
96 

97 

Source: responses by national regulators to questionnaire by the Commission services. 
Source: responses by national regulators to questionnaire by the Commission services. 
On  20  May  2010,  the  Dutch  parliament  adopted  a  motion  calling  for  a  similar  ban  on  naked  short 
selling  as  that  introduced  by  Germany  due  to  fears  that  it  created  "the  danger  that  [speculators]  are 
diverted  to  the  Netherlands",  Financial  Times,  Dutch  Parliament  calls  for  short  selling  ban,  21  May 
2010. 
European  Financial  Management  Association  (EFAMA),  Reply  to  CESR's  Call  for  Evidence  on 
Regulation of Short Selling by CESR Members, January 20 2009. EFAMA considers that the divergence 
created regulatory arbitrage possibilities "due to the many differences in the short selling regimes and 
the  cross-border  nature  of  equity  markets",  which  sometimes  caused  "distortions  that  negatively 
impacted the trading in specific shares or markets".  

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particular  causing  difficulties98.  It  also  created  significant  costs  for  participants  in 
setting  up  trading  and  reporting  systems  that  could  comply  with  the  differing 
requirements99.  

In  addition  to  unanimous  support  of  regulators  within  CESR  for  an  EU-wide  short 
selling  disclosure  regime,  most  national  regulators  have  also  expressed  strong 
support  for  a  coordinated  European  approach  to  the  powers  of  regulators  on  short 
selling in exceptional situtations100.  

To  summarise,  the  problem  of  fragmented  national  rules  on  short  selling  is  a 
significant problem at the European level, which cannot be addressed at the national 
level  alone.  Action  to  coordinate  national  responses  is  based  on  evidence  of 
regulatory  developments  which  are  expected  to  affect  market  developments 
unfavourably. 

3.7. 

How would the problem evolve without EU action? The Baseline Scenario  

As outlined above, a number of Member States have already taken national action to 
restrict  or  ban  short  selling  in  distressed  markets,  and  one  Member  State  has 
introduced  temporary  restrictions  on  naked  CDS.  This  suggests  that  even  in  the 
absence of EU action, at least some Member States consider that they have the power 
to  act,  and  have  done  so.  On  the  other  hand,  the  actions  taken  by  some  Member 
States  (e.g.  the  UK)  with  regard  to  short  selling  restrictions  and  disclosure 
requirements  in  an  emergency  were  based  on  the  Market  Abuse  Directive,  which 
does not offer sufficient legal certainty and clarity for this purpose, since it does not 
contain  any  specific  provisions  on  short  selling.  In  addition,  some  Member  States 
(e.g.  Italy)  have  indicated  that  they  would  prefer  a  coordinated  approach  to  the 
regulation  of  short  selling  at  EU  level.  The  existence  of  different  and  changing 
national rules on short selling would imply additional compliance costs for investors 
operating  in  several  EU  markets,  such  as  legal  costs  in  identifying  the  different 
national rules and setting up or updating compliance processes for these.  

In addition to the possibility of action by national regulators, many stock exchanges 
already  have  the  ability  to  suspend  trading  in  a  particular  share  whose  price  has 

98 

99 

100 

Emilios  Avgouleas,  A  new  framework  for  the  global  regulation  of  short  sales:  Why  prohibition  is 
inefficient  and  disclosure  insufficient,  University  of  Manchester  School  of  Law,  p.  18:  "The  market 
maker  exemption  was  a  source  of  particularly  serious  problems.  Most  Member  States  either  did  not 
have any market maker exemption or uniform definition about the kind of market actors that qualified 
as  market  makers.  Arguably,  the  whole  episode  showed  in  the  most  vivid  manner  how  the  lack  of 
harmonisation  of  trading  rules  keeps  the  EU  from  achieving  the  objective  of  'level  playing  field', 
arguably the holy grail of EU securities regulation." 
The  Association  of  British  Insurers  (ABI)  said  in  its  response  to  CESR's  consultation  on  short  sales: 
"The disparity of approaches taken not just in the EU but globally has represented a significant cost. For 
example,  one  large  firm,  which  operates  in  several  jurisdictions,  reports  that  the  annual  legal  and 
consultancy fees paid merely for identifying and tracking changes runs to tens of thousands of pounds." 
Association  of  British  Insurers  (ABI),  Regulation  of  Short  Selling  by  CESR  Members  –  the  ABI's 
Response to CESR 08/1010. 
Source:  discussion  with  national  regulators  (see  annex  4)  and  individual  responses  by  national 
regulators to questionnaire by the Commission services. 

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fallen by a significant amount (circuit breakers)101, and so it could be argued that no 
further  regulatory  intervention  is  required.  However,  circuit  breakers  operated  by 
stock  exchanges  only  very  briefly  suspend  trading  in  shares  which  breach  the 
specified threshold. A degree of transparency on levels of short selling in particular 
instruments  can  be  obtained  through  data  on  securities  lending,  which  can  be 
purchased  from  data  providers.  However,  since  short  selling  is  not  the  only  reason 
for borrowing securities, the use of stock lending as a proxy for levels of short selling 
presents uncertainties. 

Overall,  if  no  action  is  taken  at  EU  level  the  problems  defined  in  this  section  are 
likely to remain without a coordinated response and to occur again in the future. In 
particular,  in  the  event  of  a  renewed  sudden  and  repetitive  drop  in  the  prices  of 
sovereign bonds and the related CDS market, or of a future financial crisis, Member 
States are likely to continue to take different approaches, without prior coordination, 
to exceptional measures to reduce the negative price spirals which can be associated 
with short selling in these situations. There would be a risk of renewed stock market 
volatility  as  occurred  following  the  decision  of  Germany  to  restrict  naked  short 
selling and naked CDS.  

With  regard  to  transparency,  some  Member  States  may  impose  national  disclosure 
obligations as proposed by CESR in the absence of EU legislation; but it is likely to 
be  only  a  minority  of  countries  since  national  competent  authorities  have  agreed 
unanimously in CESR to urge the Commission to include these obligations in an EU 
legislative framework. Therefore in the absence of EU or national action to require 
disclosure of short positions to regulators and the market, regulators will continue to 
lack information on short selling transactions and information asymmetries between 
short  sellers  and  uninformed  investors  will  persist.  These  transparency  deficiencies 
imply potential risks for financial stability, as well for investor protection and market 
integrity. 

Although  believed  to  be  small  in  Europe,  settlement  failures  linked  to  naked  short 
selling  would  also  persist  in  the  absence  of  measures  to  strengthen  settlement 
discipline or require short sellers to locate or borrow shares prior to a short sale.  

In addition to the above-mentioned problems associated with the lack of a regulatory 
response  at  national  level,  there  are  also  risks  of  over-regulation  at  national  level. 
Unduly stringent rules on short selling risk having a negative impact on liquidity and 
efficient price discovery. 

Overall,  uncoordinated  national  responses  (or  the  lack  of  national  actions)  in  the 
future are likely to lead to an unlevel playing field and opportunities for regulatory 
arbitrage,  which  could  hinder  the  effectiveness  of  national  actions.  If  one  Member 
State bans short selling of some or all financial instruments on their market, investors 
could  circumvent  this  ban  by  short  selling  the  instruments  if  these  are  admitted  to 
trading on markets in other Member States not subject to the ban.  

101 

For example, the London Stock Exchange operates automatic execution suspension periods which are 
designed to provide a pause in trading of approximately five minutes when a share price fall breaches a 
specified threshold, e.g. 5%.  

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Furthermore, the timing of a European measure is also relevant in this case. With the 
adoption  of  an  early  measure  at  EU  level,  national  responses  can  be  better 
coordinated, ensuring that market participants only incur compliance costs once. The 
longer it takes to propose a clear European initiative, the more Member States may 
be  expected  to  introduce  uncoordinated  national  rules,  leading  to  a  potential 
multiplication  of  compliance  costs  for  the  financial  industry  in  the  respective 
markets.  

Finally, in the absence of EU action, the European Union will continue to lag behind 
other  countries,  notably  the  United  States,  in  their  regulatory  response  to  the  risks 
associated with short selling.  

3.8. 

Subsidiarity  

According  to  the  principle  of  subsidiarity  (Article  5.3  of  the  TFEU),  action  on  EU 
level should be taken only when the aims envisaged cannot be achieved sufficiently 
by  Member  States  alone  and  can  therefore,  by  reason  of  the  scale  or  effects  of  the 
proposed  action,  be  better  achieved  by  the  EU.  The  preceding  analysis  has  shown 
that  although  all  the  problems  outlined  above  have  important  implications  for  each 
individual Member State, their overall impact can only be fully perceived in a cross-
border context. This is because short selling a financial instrument can be carried out 
wherever that instrument is listed, or over the counter, so even in markets other than 
the primary market of the issuer concerned. Further, the CDS market is by its very 
nature a highly cross-border, even international, market. Therefore there is a real risk 
of national responses to short selling and CDS being circumvented or ineffective in 
the absence of EU level action. 

Further,  certain  aspects  of  this  issue  are  already  partly  covered  by  the  acquis, 
notably: the Market Abuse Directive which prohibits short selling which is used to 
manipulate the market or in conjunction with insider information; the Transparency 
Directive102,  which  requires  the  disclosure  of  significant  long  positions;  and  the 
Markets  in  Financial  Instruments  Directive  which  imposes  certain  requirements  on 
settlement  discipline.  Therefore  a  proposal  on  short  selling  and  these  existing  legal 
instruments  should  complement  each  other,  and  this  can  best  be  achieved  in  a 
common effort. Against this background EU action appears appropriate in terms of 
the principle of subsidiarity. 

4. 

OBJECTIVES 

4.1. 

General, specific and operational objectives 

In light of the analysis of the risks and problems above, the general objectives of the 
legislative proposal on short selling are to:  

1. reduce the risks to financial stability;  

102 

Directive  2004/109/EC  of  the  European  Parliament  and  of  the  Council  of  15  December  2004  on  the 
harmonisation of transparency requirements in relation to information about issuers whose securities are 
admitted to trading on a regulated market and amending Directive 2001/34/EC, OJ L390/38, 31.12.2004 

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2. reduce systemic risks; and  

3. reduce risks to market integrity arising from short selling; and 

4.  prevent  market  fragmentation,  thereby  increasing  the  efficiency  of  the  internal 
market.  

The  main  general  objective,  following  the  weight  of  the  above  problems,  is  to 
address the problem of market fragmentation. The other three general objectives are 
based  on  the  principle  of  risk  prevention.  However,  it  should  be  recalled  that  the 
prevention of market abuse is not specifically linked to short selling and this issue is 
therefore dealt with in the context of the review of the Market Abuse Directive rather 
than in this initiative.  

Reaching  these  general  objectives  requires  the  realisation  of  the  following  more 
specific policy objectives: 

(1) 

(2) 

(3) 

(4) 

Reduce  the  risks  of  negative  price  spirals  arising  from  short  positions 
(including those obtained through CDS); 

Increase the transparency of short positions (including those obtained through 
CDS); 

Reduce settlement risk linked with 'naked' short selling; and 

Reduce the scope for regulatory arbitrage and compliance costs. 

The  specific  objectives  listed  above  require  the  attainment  of  the  following 
operational objectives: 

(1) 

(2) 

(3) 

(4) 

Ensure regulators have clear power to restrict or ban short selling or CDS in 
distressed markets; 

Ensure that  regulators and markets obtain data  on short positions (including 
through CDS); 

Ensure  certain  requirements  are  introduced  at  the  point  of  trading  and 
strengthen settlement discipline; 

Ensure  a  coordinated  response  by  EU  Member  States  to  short  selling  and 
CDS. 

An overview of the various objectives and their interrelationships is depicted in the 
figure 

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below.

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4.2. 

Consistency of the objectives with other EU policies 

The identified objectives are coherent with the EU's fundamental goals of promoting 
a harmonious and sustainable development of economic activities, a high degree of 
competitiveness, and a high level of consumer protection, which includes safety and 
economic interests of citizens (Article 169 TFEU). 

These  objectives  are  also  consistent  with  the  reform  programme  proposed  by  the 
European  Commission  in  its  Communication  Driving  European  Recovery.103  More 
recently in the Commission Communication of 2 June 2010 on "Regulating Financial 
Services  for  Sustainable  Growth"  the  Commission  indicated  that  it  would  propose 
appropriate measures relating to short selling and credit default swaps104.  

5. 

POLICY OPTIONS 

In  order  to  meet  the  objectives  set  out  in  the  previous  section,  the  Commission 
services  have  analysed  different  policy  options.  The  first  section  reflects  the  most 
relevant policy options that have been considered in order to ensure regulators have 
the power to restrict or ban short selling or CDS in distressed markets. The second 
section examines the policy options that have been analysed in relation to ensuring 
regulators and markets obtain data on short positions (including through CDS). The 
third  section  studies  the  policy  options  considered  with  regard  to  ensuring  certain 
requirements at the point of trading and strengthening settlement discipline. Finally, 
the fourth section considers the choice of instruments available to reduce regulatory 
arbitrage and compliance costs. 

As explained in section 3.7, a number of options are not assessed below as they are 
being considered in the impact assessments for other related initiatives. 

Where necessary, further explanation of the content of the options is included in the 
assessment  of  the  options.  In  addition,  an  overview  of  the  scope  of  the  preferred 
options (with regard to the financial instruments covered) is included in annex 9. 

5.1. 

Policy  options  to  ensure  regulators  have  the  power  to  restrict  or  ban  short 
selling or CDS in distressed markets 

(1) 

(2) 

Option 1 – take no action at EU level. 

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  prohibits  short  selling  of  a  financial 
instrument admitted to trading on an organised market except at a price above 

103 
104 

Communication for the spring European Council, Driving European recovery, COM(2009)114. 
Page  7  of  the  Communication  of  2  June  2010  from  the  Commission  to  the  European  Parliament,  the 
Council, the European Economic and Social Committee and the European Central Bank. 

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the last traded price of the instrument, or at the last traded price if that price 
was higher than the price in the previous trade (an 'uptick rule'). 

Option 4 - introduce a ban on 'naked CDS' (i.e. entering into a CDS contract 
without  having  an  underlying  insurable  interest).  This  option  is  compatible 
with options 2 and 3. 

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 case of an adverse event or development that creates a threat to 
financial  stability  or  market  confidence  ('exceptional  situations'),  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 the same Regulation. This option is compatible with options 2, 3 and 4. 

Option  6  –  introduce  a  permanent  ban  on  short  selling  of  all  financial 
instruments capable of being sold short. This option is compatible with option 
4. 

Option  7  -  introduce  permanent  restrictions  or  ban  on  CDS.  This  option  is 
compatible with options 2, 3 and 6. 

(4) 

(5) 

(6) 

(7) 

5.2. 

Policy  options  to  ensure  certain  requirements  at  the  point  of  trading  and 
strengthen settlement discipline 

(8) 

(9) 

Option 1 - take no action at EU level. 

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  which  ensure  that  he  will  be  able  to 
borrow the share at the time of settlement (locate rule) 

(10)  Option  3  –  introduce  EU  rules  on  settlement  discipline  so  that  persons 
engaging  in  short  sales  which  result  in  a  failure  to  deliver  face  appropriate 
penalties, with buy-in procedures and fines in case of settlement failures 

(11)  Option 4 - introduce a ban on naked short selling 

(12)  Option  5  -  exemption  for  market  makers  and  certain  primary  market 

operations. This option is compatible with options 2, 3 and 4. 

5.3. 

Policy options to ensure regulators and markets obtain data on short positions 
(including through CDS) 

(5) 

(6) 

(7) 

Option 1 - take no action at EU level. 

Option  2  -  introduce  a  system  of  flagging  of  short  sale  transactions  so  that 
regulators can identify which transactions are 'long' and which are 'short'. 

Option  3  -  notification  of  short  positions  to  the  regulator.  This  option  is 
compatible with option 2. 

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38 

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(8) 

(9) 

Option  4  -  disclosure  of  short  positions  to  the  public.  This  option  is 
compatible with options 2 and 3.  

Option  5  -  aggregated  disclosure  of  short  positions  (i.e.  individual  short 
positions  of  investors  are  not  disclosed).  This  option  is  compatible  with 
options 2, 3 and 4. 

(10)  Option 6 - disclosure of individual significant net short positions. This option 

is compatible with options 2, 3 and 4. 

(11)  Option  7  -  exemption  from  disclosure  requirements  for  market  makers  and 
certain primary market operations. This option is compatible with options 2-
6. 

5.4. 

Policy options to ensure a coordinated response by EU member states to short 
selling and CDS 

This  objective  should  be  met  by  the  above  three  categories  of  targeted  options.  In 
addition,  the  choice  of  legal  instrument  should  also  aim  to  ensure  coordinated 
national responses. 

6. 

ANALYSIS OF IMPACTS AND CHOICE OF PREFERRED OPTIONS AND INSTRUMENTS 

This  section  discusses  the  advantages  and  disadvantages  of  the  different  policy 
options  against  the  criteria  of  their  effectiveness  in  achieving  the  related  objectives 
(to be specified for each basket of options), and their efficiency in terms of achieving 
these options for a given level of resources or at least cost. 

The  options  are  measured  against  the  above-mentioned  pre-defined  criteria  in  the 
tables  below.  Each  scenario  is  rated  between  "---"  (very  negative),  0  (neutral)  and 
"+++"  (very  positive).  The  assessment  highlights  the  policy  option  which  is  best 
placed to reach the related objectives outlined in section 5 and therefore the preferred 
one. 

6.1. 

Analysis of impacts of policy options 

6.1.1.  Policy options to ensure regulators have the power to restrict or ban short selling or 

CDS in distressed markets 

These options will be assessed primarily against their effectiveness in achieving the 
specific objectives of: reducing the risks of negative price spirals arising from short 
positions,  including  those  obtained  through  CDS;  and  reducing  the  scope  for 
regulatory arbitrage and compliance costs. These policy options will also be assessed 
on their efficiency in achieving these objectives for a given level of resources or at 
least  cost  while  avoiding  unduly  negative  effects  on  market  efficiency.  However, 
options will also be assessed against other objectives where appropriate. 

6.1.1.1  Option 1 - no action at EU level 

As  explained  in  the  problem  definition,  at  least  some  Member  States  consider  that 
they have the power to restrict or ban short selling in exceptional situations, and have 

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39 

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done so. In addition, many stock exchanges already operate circuit breakers, and so it 
could be argued that no further regulatory intervention is required.  

However,  this  option  has  shortcomings.  It  leaves  scope  for  continued  risks  of 
negative price spirals if some Member States do not act, also because circuit breakers 
operated  by  stock  exchanges  only  very  briefly  suspend  trading  in  shares.  Option  1 
also  leaves  scope  for  regulatory  arbitrage  and  increased  compliance  costs,  since  in 
the absence of EU action, Member States will continue to take divergent approaches, 
which  could  hinder  the  effectiveness  of  national  actions.  Finally,  the  existence  of 
different  and  changing  national  rules  on  short  selling  would  imply  additional 
compliance costs for investors operating in several EU markets, such as legal costs in 
identifying  the  different  national  rules  and  setting  up  or  updating  compliance 
processes for these. 

6.1.1.2  Option 2 – introduce a 'circuit breaker' 

Under  this  option,  which  could  apply  to  all  financial  instruments,  a  national 
competent authority would be given the power to temporarily prohibit short selling 
(until the end of the next trading day) in a financial instrument admitted to trading on 
an organised market whose price has fallen by a specified quantitative threshold. For 
shares, this threshold could be 10% as it is in the United States. This threshold should 
be  adapted  for  other  financial  instruments  in  implementing  technical  standards 
developed  by  ESMA  and  adopted  by  the  Commission,  where  appropriate  in 
consultation  with  other  concerned  regulators  (e.g.  for  commodity  derivatives).  The 
regulator would be informed of the price fall by the trading venue, or by electronic 
market  news  sources.  Prior  to  implementing  the  restriction  the  home  competent 
authority  would  inform  other  competent  authorities  of  countries  where  trading 
venues admitted to trading the instrument concerned by the restriction, so that they 
could also implement the circuit breaker. ESMA would also be informed but could 
not block a competent authority's decision to invoke the circuit breaker. However, if 
it were invoked repeatedly by several authorities this could be a signal to ESMA that 
longer lasting and more comprehensive exceptional measures might be required. This 
option  is  therefore  an  intermediate  step  which  could  be  combined  with  a  ban  in 
exceptional situations (option 5). 

This  option  has  some  advantages  when  compared  with  option  1.  First,  it  would 
partially achieve the objective of ensuring regulators have the power to restrict short 
selling in distressed markets, by providing regulators with a short term possibility to 
suspend  short  selling  on  the  basis  of  an  objective  price  test,  without  needing  to 
determine an exceptional situation. The second advantage is that this would prevent 
short sellers from carrying out further short transactions until the prohibition expired, 
which  could  (at  least  temporarily)  support  the  price  of  the  instrument  and  slow  or 
stop  a  negative  price  spiral.  The  third  advantage  is  that  the  discretion  left  to  the 
regulator  to  impose  (or  not)  the  prohibition  in  the  event  of  a  significant  price  fall 
would allow the regulator to decide not to impose the prohibition if they considered 
that the price fall was due to factors unrelated to short selling. 

However,  there  are  a  number  of  disadvantages  to  this  option.  First,  there  would  be 
continued scope for negative price spirals, as the prohibition of short selling would 
only  be  for  a  very  short  period  and  would  have  to  be  re-imposed  in  the  event  of  a 
further significant price fall. Second, if introduced in isolation this option still leaves 

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40 

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room for regulatory arbitrage. By its nature a 'circuit breaker' is designed to halt the 
decline in the price of an instrument105 admitted to trading on an organised market, 
and such a measure would not prevent investors from circumventing the prohibition 
of short selling on organised markets by securing a short position outside the market 
or through the use of derivatives.  

The  evidence  from  published  studies  on  the  effectiveness  of  circuit  breakers  is 
mixed. On the negative side, according to some studies, circuit breakers may cause 
volatility to be spread out over a long period of time instead of occurring in a one day 
jump,  or  may  interfere  with  market  liquidity106.  On  the  positive  side,  some  studies 
take the view that circuit breakers provide a cooling-off period for investors107. 

The  views  of  respondents  to  the  Commission's  public  consultation  on  the  circuit 
breaker  option  were  mixed,  and  a  large  number  of  respondents  did  not  provide 
comment on this area. The majority of those who did noted that it could be a useful 
tool to slow a price fall amplified by short selling, but that similar tools were already 
in  place  on  exchanges  and  markets  across  the  EU.  No  data  was  provided  on  the 
compliance costs linked to the circuit breaker option.  

6.1.1.3  Option 3 – introduce an 'uptick rule' 

The advantages of option 3 compared to option 1 are as follows. It would address the 
first shortcoming of option 1, as a short sale transaction could only be entered at a 
higher price than the last trade price, which would limit the scope for negative price 
spirals to  occur,  without stopping  short selling in a flat or advancing market. Also, 
unlike option 2, the prohibition of short selling is permanent, not temporary, so long 
as  the  short  sale  transaction  is  at  a  lower  price  than  the  last  trade  price.  It  would 
partially address the second shortcoming of option 1, as a common uptick rule for all 
EU Member States would give a greater degree of certainty on the regulatory regime 
for market participants. 

However, this option also has several disadvantages. The tick rule has been criticised 
by  some  stakeholders  for  being  ineffective  as  it  only  temporarily  decelerates  price 
declines108. In the United States, which operated a tick rule for nearly 70 years, this 
rule  was  abolished  by  the  SEC  in  2007  on  the  grounds  that  it  modestly  reduced 
liquidity and did not appear necessary to prevent manipulation109. Furthermore, like 
option  2,  if  introduced  on  its  own  a  tick  rule  would  leave  scope  for  regulatory 
arbitrage  through  the  use  of  derivatives  to  secure  an  economic  short  position,  as  a 
tick rule only applies to short transactions on cash markets.  

Most  empirical  studies  are  critical  of  the  effectiveness  of  uptick  rules,  arguing  that 
they  were  ineffective  in  preventing  price  declines  or  that  the  price  behaviour  of 

105 
106 

107 
108 

109 

In fact in the United States, the 'revised uptick rule' only applies to shares.  
For  a  review  of  the  published  literature  on  this  issue  see  Gruenewald,  S,  Wagner  A,  Weber  R,  Short 
selling Regulation after the Financial Crisis – First Principles Revisited, University of Zurich, 2009, p. 
37. 
Ibid, p. 37. 
Financial Services Authority, FS09/4, Short Selling: Feedback on DP09/1, October 2009, p. 11. 
http://www.fsa.gov.uk/pubs/discussion/fs09_04.pdf  
See SEC press release: www.sec.gov/news/press/2007/2007-114.htm  

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securities subject to an uptick rule was not substantially different to those not subject 
to such a rule.110  

6.1.1.4  Option 4 – ban 'naked CDS' 

This option would permanently prohibit investors from entering into a CDS contract 
unless  they  held  an  underlying  insurable  interest.  This  option  only  concerns  CDS 
contracts without an underlying insurable interest, so it has a narrower scope than a 
short  selling  ban  which  would  prohibit  investors  from  selling  short  any  financial 
instrument. 

Option  4  has  the  advantage  over  option  1  that  it  may  help  to  reduce  the  risk  of 
negative  price  spirals  in  the  bond  markets  linked  to  economic  short  positions 
obtained  through  naked  CDS,  thereby  partially  fulfilling  the  first  specific  policy 
objective. A common approach to banning naked CDS would also partially address 
the  second  shortcoming  of  option  1  (regulatory  arbitrage  and  compliance  costs)  by 
partially harmonising the approaches of Member States on the CDS aspect. 

However, option 4 has a number of potential risks and disadvantages. According to 
some  academics,  prohibiting  naked  positions  in  credit  default  swaps  could 
dramatically  impact  the  market,  because  if  the  CDS  market  is  reduced  to  hedgers 
only,  market  liquidity  is  likely  to  drop  substantially  111.  There  is  also  the  risk  that 
regulation of the CDS market could also have some side effects on the bond market. 
Under a naked CDS ban, CDS might become more like classical insurance devices, 
i.e. customised to closely-related exposure. This would reduce the market's ability to 
trade credit risk and make proxy-hedging112 impossible. As a result, the cost of bond 
market financing for the broader economy could increase. 

Another  potential  disadvantage  of  a  ban  on  naked  CDS  is  that  there  is  a  question 
mark as to whether this would be effective in achieving the objective of reducing the 
risk  of  negative  price  spirals  in  the  bond  market.  According  to  some  market 
participants  and  regulators,  there  is  no  clear  evidence  that  trading  on  the  CDS 
markets  can  distort  or  manipulate  the  underlying  bond  market,  although  some 
regulators  argue  that  there  is  a  risk  that  trading  on  the  CDS  market  can  lead  to 
instability on the underlying bond market.113  

110 

111 
112 

113 

For an overview of empirical studies on uptick rules see Avgouleas, Emilios, A new framework for the 
global  regulation  of  short  sales:  why  prohibition  is  inefficient  and  disclosure  insufficient,  Stanford 
Journal of Law, Business and Finance, Spring 2010, p. 55. 
Rene Schultz Journal of Economic Perspective Winter 2010 
Proxy  hedges  are  hedges  which  cover  a  non-deliverable  obligation  that  is  sufficiently  correlated  with 
the  deliverable  obligations.  Examples  would  be  using  sovereign  CDS  to  hedge  exposure  to  banks  or 
corporates  in  the  same  jurisdiction  or  to  hedge  exposure  to  other  sovereigns,  for  which  no  sovereign 
CDS  are  traded.  Since  CDS  are  a  synthetic  market,  it  would  of  course  be  possible  for  market 
participants  to  write  CDS  contracts  on  any  "exotic"  reference  entity.  Since  market  liquidity  for  that 
contract would be low, however, the CDS seller would require a significant premium beyond the credit 
risk. Therefore, proxy-hedging may be less precise but cheaper. 
Responses to DG MARKT Public Consultation on Short Selling. A number of respondents, including 
the Association of British Insurers, Danish Central Bank, UK Finance Ministries Joint Submission and 
the London Stock Exchange Group, noted that there was no clear evidence to support such a ban. The 
Banque De France also commented that they were not in favour of a ban, and noted the differences in 
correlation across the sovereign CDS/Bond market. The German Federal Ministry of Finance, AMF and 
CNMV noted that they believed there was such a correlation. 

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Moreover,  concerns  about  the  possible  damaging  effects  of  a  ban  on  naked  CDS 
have to be taken with care as there is no certainty about the positive impact of CDS 
on  the  accuracy  of  pricing  on  the  bond  markets.  Empirically,  this  issue  has  been 
studied for corporate debt by Ashcraft and Santos (2009) with mixed findings.114 The 
authors  do  not  find  evidence  that  the  average  firm  on  which  CDS  are  traded  has 
benefited  from  a  reduction  in  the  credit  spreads  that  it  pays  to  issue  in  the  bond 
market or to borrow from banks. However, there is evidence that the onset of CDS 
trading has increased the cost of debt financing for the riskier firms as well as those 
that  are  more  informationally  opaque.  In  contrast,  safer  and  more  transparent  firms 
experience a small reduction in the spreads after their CDS started to trade. 

For  sovereign  CDS,  no  similar  study  exists.  As  the  assessment  of  sovereign 
creditworthiness  by  and  large  rests  on  public  information,  reduced  screening 
incentives  through  CDS  should  play  only  a  minor  role.  However,  rather  opaque 
public accounts have been important in the recent sovereign debt crisis.  

Finally,  this  option  has  the  disadvantage  that  if  it  were  to  be  adopted  in  isolation 
there would be a risk of regulatory arbitrage, as there are other strategies than naked 
CDS to bet on a downturn on sovereign or corporate risk which would also need to 
be addressed in order for any ban to be effective: selling a future on the bond, buying 
a put option, selling a call option, or short selling the bond.  

Overall, there are very varied views on how the bond market would be affected by a 
ban on naked CDS. 

Most  respondents  to  the  public  consultation  who  addressed  this  option  in  their 
contributions  opposed  a  ban  on  naked  CDS,  arguing  that  there  was  insufficient 
evidence to suggest naked CDS positions had been used in an abuse manor. On the 
contrary,  a  number  of  financial  and  non  financial  institutions  (e.g.  manufacturers) 
cited  the  use  of  proxy-hedging  as  critical  to  the  effective  management  of  financial 
and non financial risks. 

6.1.1.5  Option 5 – power for national regulators to temporarily restrict or ban short selling or 

CDS in exceptional situations (coordinated by ESMA) 

Under this option, national competent authorities would, in case of an adverse event 
or  development  that  creates  a  threat  to  financial  stability  or  market  confidence 
('exceptional  situations'),  be  granted  a  clear  power  to  temporarily  restrict  (e.g.  by 
banning naked short selling or naked CDS) or ban short selling or limit other similar 
transactions.  A  national  competent  authority  could  invoke  these  powers  of 
intervention if it considered it necessary in the event of adverse developments which 
constituted  a  serious  threat  to  financial  stability  or  to  market  confidence  in  the 
Member State, another Member State or the Union. The scope of the power would be 
broad,  covering  any  financial  instrument,  to  provide  flexibility  to  regulators  to 
respond  to  an  exceptional  situation.  The  Commission  would  further  specify  the 
criteria for determining an exceptional situation by means of a delegated act, which 
gives the European Parliament and the Council the possibility to object and prevent it 
from entering into force. 

114 

Ashcraft, A. and Santos, J. (2009), Has the CDS market lowered the cost of corporate debt?, Journal of 
Monetary Economics, 56, pp. 514-23. 

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To  ensure  coordination,  ESMA  would  have  to  be  notified  not  less  than  24  hours 
before (unless there were exceptional circumstances) and ESMA would then issue an 
opinion.  In  this  opinion,  ESMA  would  state  whether  it  considers  that  adverse 
developments have arisen which constitute a serious threat to financial stability or to 
market  confidence  in  a  Member  State  or  the  Union,  whether  the  measures  are 
appropriate  and  proportionate  to  address  the  threat  and  whether  the  proposed 
duration  of  the  measures  are  justified.  Where  ESMA  concludes  that  the  action  is 
justified,  it  would  also  state  whether  action  by  other  competent  authorities  is 
necessary.  The  opinion  would  be  published  on  ESMA's  website.  If  a  national 
regulator then wished to continue with action contrary to ESMA's opinion, it would 
have to publicly explain its decision. The short notification period and the possibility 
for  Member  States  to  give  less  notice  in  exceptional  circumstances  would  ensure 
coordination  while  enabling  competent  authorities  to  act  quickly  in  fast-moving 
situations.  

Consistent with an amendment to the ESMA Regulation adopted in first reading by 
the European Parliament115, ESMA itself would be given the power of intervention 
on short selling where an exceptional situation arose in a Member State or the Union 
which had cross-border implications and a competent authority or authorities had not 
already taken action, or taken sufficient action. If the threat was particularly serious, 
ESMA  could  intervene  without  first  issuing  an  opinion.  The  same  notification 
requirements would apply to ESMA. Restrictions in an exceptional situation could be 
applied for up to 3 months and, if justified, could be renewed for further periods of 
the same duration, and ESMA would ensure that the renewal would not exceed the 
period which was justified and proportionate. 

This  option  has  a  number  of  advantages.  First,  by  providing  regulators  with  the 
power to act in distressed markets it would also achieve the first specific objective of 
reducing the risk of negative price spirals. It would be more effective than options 2, 
3  and  4  in  fulfilling  the  first  operational  objective,  since  it  would  ensure  that 
regulators  would  be  granted  the  power  to  restrict  or  ban  short  selling  or  CDS  in 
exceptional situations. Second, since the power to restrict or ban short selling or CDS 
would be confined to such exceptional situations, any possible negative impacts on 
market  efficiency  of  such  a  ban  would  be  limited  to  the  duration  of  the  threat  to 
financial stability or market confidence, which would contribute to achieving general 
objective 4 (prevent market fragmentation/enhance efficiency of internal market).  

Third, if ESMA were to be granted the power to ensure that the actions of regulators 
in  exceptional  situations  were  coordinated  and  consistent,  this  would  meet 

115 

Article 6a(5) of the ESMA Regulation as adopted by the European Parliament says that "the Authority 
may temporarily prohibit or restrict certain financial activities that threaten the orderly functioning and 
integrity of financial markets or the stability of the whole or part of the financial system in the Union in 
the cases specified and under the conditions laid down in the legislative acts referred to in Article 1(2) 
or if so required in the case of an emergency situation in accordance with and under the conditions laid 
down  in  article  10.  The  Authority  may  also  assess  the  need  to  prohibit  or  restrict  certain  types  of 
financial  activities  and,  where  there  is  such  a  need,  inform  the  Commission  in  order  to  facilitate  the 
adoption of any prohibition or restriction. The authority shall review its decision at appropriate intervals 
and  at  least  every  three  months.  If  the  decision  is  not  renewed  after  those  three  months,  it  shall 
automatically expire. A Member State can appeal against the decision of the Authority. In that case, the 
Authority  shall  decide  in  accordance  with  Article  29(1)  subparagraph  2,  whether  it  maintains  its 
decision."  

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operational  objective  4  and  reduce  the  scope  for  regulatory  arbitrage  (specific 
objective 4). This option would increase the effectiveness of national actions, since 
regulators would be required to cooperate with each other to enforce the measures. It 
would  also  reduce  compliance  costs  as  market  participants  would  have  to  comply 
with  coordinated  measures  across  the  EU  in  an  exceptional  situation,  rather  than  a 
patchwork of different national responses. 

The first disadvantage of this option is the potential for negative impacts on market 
efficiency. A study by Beber and Pagano which analysed short selling bans around 
the  world  between  2007  and  2009  concluded  that  bans  and  constraints  on  short 
selling were "detrimental for market liquidity" and may not have the intended effect 
of  supporting  market  prices116.  A  temporary  ban  could  also  have  negative 
implications  for  efficient  price  discovery:  an  analysis  of  short  selling  data  and 
restrictions  in  46  markets  across  the  world  by  Bris  et  al  concludes  that  "markets 
where  short  sales  are  allowed  are  more  efficient  because  bad  news  appears  to  be 
more rapidly impounded into prices."117 However, these impacts would only last for 
the duration of any temporary restrictions or bans on short selling or CDS, and have 
to  be  balanced  against  the  benefits  which  such  restrictions  could  bring  in  terms  of 
reducing the risk of negative price spirals in distressed markets. 

The  second  disadvantage  is  the  cost  for  market  participants  of  compliance  with  a 
ban, which would include, for example, legal advice and adjustments of IT systems 
to  prevent  short  selling  of  the  instruments  concerned.  The  FSA  conducted  a  cost 
benefit  analysis  of  its  temporary  ban  on  short  selling  of  shares  in  UK  financial 
institutions  in  2008,  and  estimated  the  one-off  compliance  costs  to  be  GBP  40,000 
per firm and the ongoing costs to be GBP 6,500 per firm per month.118 On the other 
hand,  ongoing  costs  would  only  last  for  as  long  as  the  ban  was  in  place,  and  these 
costs also have to be weighed against the reduced risk of negative price spirals which 
this option could bring. 

The other main disadvantages of this option is, that if ESMA were not in practice to 
have the ability to ensure real and effective coordination and consistency in national 
measures  taken  in  exceptional  situations,  there  would  be  a  risk  of  continued 
regulatory  arbitrage  and  higher  compliance  costs  for  market  participants,  similar  to 
the  second  shortcoming  of  option  1.  However,  since  the  coordination  powers 
foreseen for ESMA under this option are extensive and would be without prejudice 
to its powers under article 10 (emergency powers) of the ESMA Regulation, this risk 
is limited as ESMA could always act itself or invoke article 10 to ensure that national 
regulators took the same action in an emergency.  

Most  responses  to  the  public  consultation  favoured  this  option  as  they  felt  limiting 
restrictions to exceptional situations would be a strong signal to the market and act as 
a  damper  to  mitigate  speculation.  There  was  also  support  from  market  participants 
for the clear definition of an exceptional situation, which would help maintain market 

116 

117 

118 

Beber, Alessandro and Pagano, Marco, Short-Selling Bans around the World: Evidence from the 2007-
09 Crisis, CSEF working paper, 2010, p. 27. 
Bris, Arturo, William N. Goetzmann, W.N., Zhu, N., Efficiency and the bear: Short sales and markets 
around the world, 2007, Journal of Finance, Vol 62, No 3, p. 28. 
FSA DP09/1 (February 2009), annex 3, p. 2.  

EN 

45 

   EN 

                                                 
clarity  and  confidence.  On  the  other  hand,  public  authorities  mostly  argued  for 
flexibility in determining an exceptional situation. 

6.1.1.6  Option 6 – permanent ban on short selling 

This  option  would  mean  that  investors  would  be  banned  permanently  from  short 
selling financial instruments, either through short selling on cash markets or through 
the use of derivatives to secure a net short position. 

The  main  advantage  of  a  permanent  ban  on  short  selling  would  be  that  it  would 
eliminate  the  potential  for  the  risk  that  short  selling  may  amplify  negative  price 
spirals in distressed markets, as well as the risk of settlement failures linked to naked 
short  selling.  If  short  selling  were  to  be  banned,  there  would  not  be  a  need  for  a 
disclosure  regime  for  short  positions,  and  a  total  EU-wide  ban  would  rule  out  the 
possibility of regulatory arbitrage in Europe and additional compliance costs caused 
by differing national rules. 

However,  there  would  clearly  be  major  costs  associated  with  this  option.  The 
economic costs (in terms of market liquidity and price efficiency) outlined for option 
5  would  be  even  greater  under  this  option,  as  the  ban  would  be  permanent,  not 
temporary. Similarly, the ongoing compliance costs would be greater than for option 
5 as they would not be limited in time (although one-off costs would only have to be 
incurred  once,  whereas  in  a  temporary  regime  these  would  recur  with  each  new 
restriction).  This  option  would  therefore  not  meet  the  objective  of  avoiding  unduly 
negative effects on market efficiency. 

Further, since most other countries do not have a permanent ban on short selling in 
place, there would be a risk that such a measure might lead to challenges before the 
World Trade Organisation, or to economic retaliation by other countries opposed to 
this approach. There would also be a risk that the attractiveness of Europe as a base 
for  financial  institutions  would  be  reduced,  and  that  over  time  they  might  opt  to 
locate  themselves  in  jurisdictions  which  gave  them  greater  freedom  in  their 
investment strategies119.  

Only  two  of  the  116  responses  to  the  public  consultation  supported  a  full  ban  on 
short selling.120  

6.1.1.7  Option 7 – permanent restrictions or ban on CDS 

The  advantage  of  this  option  is  that  it  would  eliminate  the  potential  for  CDS  to  be 
used  to  secure  an  economic  short  position  in  the  underlying  reference  instruments, 
and  would  therefore  further  reduce  the  scope  for  negative  price  spirals  in  those 
instruments. Like option 6 it would eliminate the need for a transparency regime for 
economic short positions obtained through CDS. 

119 

120 

In the response of the Alternative Investment Managers Association (AIMA) to a questionnaire by the 
Commission services, one hedge fund argued that a ban on short selling through the use of derivatives 
would force it to move outside the EU, and another argued that listings and trading would move to the 
US and Asian markets. 
Responses  to  DG  MARKT  Public  Consultation  on  Short  Selling.  Stellungnahme  des  Deutschen 
Gewerkschaftsbundes and John Chapman. 

EN 

46 

   EN 

                                                 
However,  this  option  has  similar  disadvantages  to  option  6.  There  would  be 
considerable economic costs to this measure, as institutions would no longer be able 
to  hedge  credit  risk  through  CDS  or  take  positions  for  a  profit.  The  ongoing 
compliance costs would be greater than for option 5 as they would not be limited in 
time.  Since  the  CDS  market  is  a  highly  global  one,  a  ban  could  easily  be 
circumvented by investors trading in CDS in non-EU countries not subject to the ban 
and there would be very little that EU regulators could do about this.  

6.1.1.8  The preferred options 

Option 1 (baseline) 

n.a. 

n.a. 

n.a. 

Impact on stakeholders 

Effectiveness 

Efficiency 

Option 2 
(circuit breaker) 

Option 3 
(uptick rule) 

Option 4 
(ban on naked CDS) 

Option 5 
(power for national 
regulators to ban 
short selling/CDS in 
exceptional 
situations, subject to 
ESMA coordination) 

Option 6 
(permanent ban on 
short selling) 

Option 7 
(permanent ban on 
CDS) 

(++) regulators obtain possibility to 
temporarily ban short selling and have 
discretion not to ban 
(++) issuers gain a mechanism to 
temporarily support their share price 
when it faces a significant decline 
(-) financial institutions engaging in 
short selling are briefly restricted from 
doing so and face compliance costs 

(+) regulators have an ongoing 
automatic mechanism  
(+) issuers gain an ongoing, automatic 
mechanism to support their share price  
(- - ) financial institutions face 
compliance costs and are permanently 
restricted form short selling 
(+) regulators gain a tool to eliminate 
risk of negative price spirals on bond 
markets linked to naked CDS 
(0) governments benefit from possible 
reduced volatility on sovereign bond 
markets, but risk of negative side 
effects on liquidity 
(- - -) financial institutions lose a way 
of taking negative positions on bond 
markets through CDS 

(+++) ensures regulators gain powers 
to ban short selling/CDS in exceptional 
situations  
(++) issuers gain comfort of knowing 
that their share price can be supported 
by a temporary ban on short selling in 
distressed markets 
(0) governments benefit from possible 
reduced volatility on sovereign bond 
markets, but risk of negative side 
effects on liquidity 
(- -) financial institutions engaging in 
short selling may be prevented from 
doing so in exceptional situations for 
several months 

(-) regulators lose discretion to only 
ban short selling in exceptional 
situations 
(++) share prices of issuers would be 
supported, but this could lead to them 
being artificially inflated  
(- - -) financial institutions prevented 
from short selling permanently 
(-) regulators lose discretion to only 
ban CDS in exceptional situations 
(0) governments benefit from possible 
reduced volatility on sovereign bond 
markets, but risk of negative side 

(++) partially achieves 
specific objective 1, but 
prohibition only for a short 
period  
(-) regulatory arbitrage: 
could be circumvented by 
derivatives 

(+) partially achieves 
operational objective 1 as it 
restricts short selling in a 
falling marke 
(-) could be circumvented by 
derivatives 

(-) partially achieves 
operational objective 1 for 
bond markets, but 
effectiveness questionable. 
Could be circumvented by 
using other derivatives or 
trading CDS outside EU 

(+++) achieves operational 
objective 1 fully and reduces 
risk of negative price spirals 
arising from short positions; 
ESMA coordination 
eliminates risk of regulatory 
arbitrage 

(-) compliance costs for 
investors; any effect on 
liquidity would be 
temporary 

(- --) compliance costs; 
could reduce market 
liquidity 

(- - -) could 
substantially reduce 
liquidity of CDS market 
and could have 
negative side effects on 
bond markets 

(-) reduced compliance 
costs compared to 
other options due to 
coordinated EU 
approach. Temporary 
restrictions in 
exceptional situations 
avoid unduly negative 
impacts on market 
efficiency, although 
temporary restrictions 
on CDS could have 
negative side effects on 
bond markets. 

(+) partially achieves 
operational objective 1, since 
ban would not be 
discretionary and restricted 
to distressed markets. Rules 
out regulatory arbitrage. 

(- - -)Permanent costs 
in terms of reduced 
market liquidity and 
efficient price 
discovery. Ongoing 
compliance costs. Risk 
of firms relocating. 

(+) partially achieves 
operational objective 1, since 
ban would not be 
discretionary and restricted 
to distressed markets. Could 

(- - -) substantial costs 
as firms lose ability to 
hedge credit risk and 
could have negative 
side effects on 

EN 

47 

   EN 

 
 
 
 
effects on liquidity 

be circumvented by using 
other derivatives or trading 
CDS outside EU 

sovereign bond 
markets 

Based on the analysis above, the highest scoring option is option 5, granting a power 
for  national  regulators  to  temporarily  restrict  or  ban  short  selling  or  CDS  in 
exceptional  situations  (coordinated  by  ESMA).  However,  option  2  also  scores  well 
and is compatible with option 5. In fact, if option 2 were to be combined with option 
5,  this  would  address  the  shortcomings  of  option  2:  that  short  positions  using 
derivatives are not captured, and that the halt to short selling in the event of is only a 
very short term one (until the end of the next trading day). A combination of the two 
options  would  give  regulators  an  instrument  to  impose  a  short  term  ban  on  short 
selling  on  organised  markets  in  the  event  of  a  significant  price  decline,  as  an 
intermediate step based on an objective price test, as well as the possibility to impose 
a temporary ban of a longer duration, capturing derivatives as well, in the event of an 
adverse  event  or  development  which  posed  a  threat  to  financial  stability  or  market 
confidence. So the preferred option is a combination of options 2 and 5. 

With regard to the circuit breaker, the scope should cover all financial instruments, 
but the threshold of 10% would apply only for shares, whereas thresholds for other 
financial instruments would be adapted to each instrument in implementing technical 
standards  adopted  by  the  Commission  on  the  advice  of  ESMA.  With  regard  to  the 
broader powers of regulators in exceptional situations the scope should extend to all 
financial  instruments  that  may  be  sold  short,  as  well  as  CDS,  to  provide  the 
necessary flexibility for regulators in unforeseen situations.  

6.1.2.  Policy options to ensure certain requirements at the point of trading and strengthen 

settlement discipline 

These  options  will  be  assessed  against  their  effectiveness  in  achieving  the  specific 
objectives of reducing settlement risk linked with naked short selling, and reducing 
the  scope  for  regulatory  arbitrage  and  compliance  costs.  These  policy  options  will 
also be assessed on their efficiency in achieving these objectives for a given level of 
resources  or  at  least  cost  while  avoiding  unduly  negative  effects  on  market 
efficiency.  However,  options  will  also  be  assessed  against  other  objectives  where 
appropriate.  

6.1.2.1  Option 1 – no action at EU level  

As  explained  in  the  problem  definition,  the  available  data  suggests  that  levels  of 
settlement  failures  in  Europe  are  relatively  low,  perhaps  as  a  result  of  the  existing 
obligations  imposed  on  market  operators  by  MiFID  or  national  rules  to  strengthen 
settlement discipline. However, a number of Member States have imposed temporary 
or  permanent  restrictions  on  naked  short  selling  because  they  perceive  risks  of 
settlement  failure  and  price  volatility,  and  in  the  absence  of  EU  level  action,  these 
risks will persist. In addition, the current diversity of national responses to the issue 
would  also  continue,  implying  scope  for  regulatory  arbitrage  and  compliance  costs 
for financial institutions operating on several EU markets. 

EN 

48 

   EN 

 
 
 
6.1.2.2  Option 2 - introduce a locate rule 

This option would involve imposing a requirement that before entering into a short 
sale,  an  investor  would  have  to  either  have  borrowed  the  security,  entered  into  an 
agreement to borrow it or have other arrangements which ensure that he will be able 
to borrow the security at the time of settlement. This is often known as a 'locate rule', 
as prior to carrying out a short sale transaction, the investor has to either borrow the 
securities or locate them with a view to borrowing them before settlement.  

A  locate  rule  has  several  advantages  compared  to  the  'no  EU  level  action'  option. 
First, it would meet the objective of reducing the risks of settlement failures which 
naked  short  selling  may  cause,  leaving  other  causal  factors  (e.g.  administrative 
errors)  to  be  dealt  with  by  other  means  (regulatory  or  non-regulatory).  Second,  a 
locate rule would slow down the speed with which a short seller could execute his 
strategy, as he would have to first borrow or locate shares to borrow entering into a 
short sale. More importantly, since there is always a limit to the quantity of securities 
available for lending, a locate rule would also place a limit on the volume of short 
selling of securities. Aggressive short term strategies which depend on placing a high 
volume  of  short  sale  orders  very  quickly  would  therefore  become  much  more 
difficult  to  carry  out.  This  would  have  the  additional  advantage  of  contributing  to 
meeting the objective of reducing the risk of negative price spirals arising from short 
positions.  

Third,  introducing  a  harmonised  locate  rule  at  EU  level  would  eliminate  the  scope 
for  regulatory  arbitrage  as  investors  could  no  longer  execute  short  sales  in 
jurisdictions with little or no restrictions on naked short selling. It would also reduce 
compliance  costs  relative  to  the  cost  of  the  very  different  national  requirements 
which  currently  exist  for  naked  short  selling,  as  institutions  would  only  have  to 
comply with one common obligation EU-wide.  

A  potential  disadvantage  with  this  option  is  that  it  could  impose  compliance  costs, 
including legal costs and the cost of IT systems to ensure that sort sale transactions 
could  only  be  executed  once  securities  had  been  borrowed  or  located.  However, 
these costs would be limited since most market participants said in their responses to 
a  questionnaire  by  the  Commission  services  that  they  already  use  arrangements  to 
ensure  securities  are  located  prior  to  entering  into  a  short  sale,  and  this  option 
foresees  that  such  arrangements could continue to be used. The public consultation 
has not provided data on the compliance costs associated with existing restrictions on 
naked short selling.  

A disadvantage of a locate rule would be that it could impose indirect economic costs 
on institutions which currently engage in naked short selling. These costs in terms of 
reduced  market  liquidity  and  efficient  price  discovery  would  likely  be  lower  than 
those for a ban on short selling, but some impact could still be expected. However, 
the evidence gathered from the bilateral and public consultations carried out by the 
Commission suggests that the prevalence of naked short selling, without any attempt 
to locate securities for borrowing, is quite limited.  

Another  significant  disadvantage  would  be  if  the  rule  did  not  contain  appropriate 
exemption  for  firms  engaged  in  market  making  activity  which  provide  significant 
liquidity to the market and due to the nature of their business need to take numerous 

EN 

49 

   EN 

naked short positions throughout the trading day. Requiring such participants to enter 
into  agreements  for  the  significant  number  of  trades  they  enter  into  would 
significantly impair their ability to provide liquidity to the market. This would have a 
significant detrimental effect on markets.  

In summary, a locate rule could be considered to be a proportionate response to the 
risk of settlement failure, as the costs involved are likely to be limited since it would 
be building on an existing market practice already used by many market participants, 
and an exemption could be foreseen for market making activities so as to minimise 
any negative impact on the liquidity they provide. A harmonised EU requirement on 
a locate rule would also reduce the compliance costs for market participants relative 
to the different approaches currently followed by Member States in this respect. 

6.1.2.3  Option 3 – introduce EU rules on settlement discipline 

Under this option, trading venues or central counterparties would be required to have 
rules  in  place  so  that  if  a  short  seller  was  unable  to  deliver  securities  by  the 
settlement  date,  procedures  would  be  triggered  to  'buy  in'  those  securities  for 
settlement after a specified period (which could be T+4), at the expense of the short 
seller.  Further  under  this  option  rules  could  require  trading  venues  or  settlement 
systems to have in place appropriate measures to fine participants who do not settle 
by the due date. Since the causes of settlement failures are broader than just naked 
short selling, under this option it is proposed that there would be only such level of 
harmonisation  as  is  necessary  to  achieve  the  relevant  objectives  on  short  selling. 
More detailed harmonisation of issues such as settlement periods, buy in procedures 
and  fining  regimes  would  be  addressed  in  the  forthcoming  European  Commission 
initiative on securities law, which will also be subject to an impact assessment.  

The  advantage  of  option  3  is  that  it  would  reduce  the  risk  of  settlement  failures 
linked  with  naked  short  selling  by  providing  for  buy-in  procedures  or  fines  in  that 
situation,  thereby  meeting  objective  3.  However,  unlike  option  2,  it  would  not  in 
itself  limit  the  speed  with  which  investors  could  short  sell,  or  the  volume  of  short 
selling,  as  it  would  not  introduce  any  requirements  at  the  point  of  trading.  The 
discipline  on  investors  would  rather  arise  from  the  knowledge  that  if  they  did  not 
have the securities to settle a short sale transaction, they would face the costs of the 
buy-in  procedures  and  fines  that  would  be  triggered.  This  would  be  a  significant 
commercial  deterrent  against  persons  entering  into  short  sales  without  having  in 
place adequate arrangements to ensure they can settle the transaction. 

As with option 2, option 3 would also reduce the scope for regulatory arbitrage and 
compliance  costs  arising  from  different  national  rules  on  settlement  failures  linked 
with naked short selling.  

In terms of compliance costs, as many trading venues already have in place differing 
forms  of  buy  in  or  fining  arrangements  for  late  settlement,  some  level  of 
harmonisation as foreseen by option 3 should not impose significant additional costs. 
The  public  consultation  provided  no  data  on  possible  costs  associated  with  this 
option. . 

EN 

50 

   EN 

6.1.2.4  Option 4 – ban on naked short selling 

This  option  would  entail  imposing  a  requirement  that  securities  could  not  be  sold 
short  unless  they had been borrowed and were  held  by  the  seller  before  he  entered 
into the short sale (a 'pre-borrow' requirement).  

A ban on naked short selling has similar advantages to a locate rule: it would reduce 
the risk of settlement failures linked to naked short selling to an even greater extent 
(although  the  evidence  from  Spain,  which  has  such  a  ban,  is  that  it  would  not 
eliminate  settlement  failures  entirely).  It  would  also  restrict  to  a  greater  extent  the 
ability  of  short  sellers  to  short  sell  quickly,  as  their  ability  to  do  so  would  be 
conditional on borrowing and actually obtaining the borrowed securities, without the 
flexibility offered by a locate rule to actually borrow the securities after the short sale 
but  before  settlement.  A  harmonised  ban  would  also  eliminate  the  scope  for 
regulatory arbitrage. 

However,  the  costs  associated  with  a  ban  on  naked  short  selling  would  be  greater 
than those linked with a locate rule. Investors would face legal costs and would have 
to  put  in  place  systems  to  ensure  that  short  sales  were  only  entered  into  when  the 
securities had been borrowed. 

The indirect economic costs of this option are also likely to be greater than for the 
locate rule. According to the economic literature, a ban on naked short selling would 
have similar effects in terms of reducing liquidity and efficient price discovery as a 
ban on short selling. 

As  with  a  locate  rule,  if  there  were  to be  no  exemption  from  a  ban  on  naked  short 
selling  for  market  making  activity,  this  would  significantly  impair  their  ability  to 
provide liquidity to the market. 

6.1.2.5.  Option  5  –  exemption  for  market  making  activity  and  certain  primary  market 

operations 

There  are  a  number  of  important  and  established  market  practices  which  are 
necessary for the efficient functioning of markets and where participants need to take 
covered or uncovered short positions to conduct such activities. These activities are 
market making activities and specific primary market operations. This option would 
exempt  these  activities  from  certain  requirements  for  uncovered  short  selling  (the 
locate rule), but not from the requirements for settlement discipline (although these 
would be adapted for market making activities and primary market operations). 

Under  this  option,  market  making  activity  would  be  defined  as  the  provision  by 
financial  institutions  of  liquidity  on  a  regular  and  ongoing  basis  to  the  market  by 
posting  firm,  simultaneous 
instruments  at 
competitive prices, or by fulfilling orders initiated by clients or in response to clients' 
requests to trade, and to hedge positions arising out of those dealings.  

two-way  quotations  of  financial 

The use of this exemption would be subject to a number of conditions to ensure that 
it  is  not  abused.  Under  this  option,  only  the  market  making  activities  of  financial 
institutions  who  meet  the  criteria  of  this  definition  and  who  have  notified  the 
regulator  30  days  beforehand  of  their  intention  to  make  use  of  the  market  maker 
exemption, would be exempt from the requirement on naked short selling considered 

EN 

51 

   EN 

in  this  section.  The  competent  authority  that  receives  a  notification  from  a  person 
wishing  to use the exemption will  be able  to refuse  to allow the person  to  use it if 
they  believe  the  person  does  not  meet  the  criteria  for  using  the  exemption.  The 
competent  authority  will  also  be  able  to  request  further  information  from  persons 
using  the  exemption  to  ascertain  if  they  are  complying  with  all  conditions.  The 
proprietary  trading  activities  of  financial  institutions  which  also  engaged  in  market 
making would not be exempt.  

Similarly,  primary  market  dealers  who  have  signed  an  agreement  with  an  issuer  of 
sovereign debt in order to provide assistance to the sovereign issuer for primary and 
secondary market operations relating to its sovereign debt would also benefit from an 
exemption  from  the  requirements  on  naked  short  selling  for  these  primary  market 
operations.  The  exemption  would  also  apply  to  primary  market  operations  by  a 
person for the purposes of stabilisation under the Market Abuse Directive. The same 
conditions would apply as outlined above.  

The  option  is  consistent  with  principle  4  of  the  International  Organisation  of 
Securities  Commission's  (IOSCO)  principles  on  short  selling,  which  recommends 
that short selling regulation should cater for market transactions that are desirable for 
efficient  market  functioning  and  development.  According  to  IOSCO,  activities  that 
fall  under  this  category  include  bona  fide  hedging,  market  making  and  arbitrage 
activities; in IOSCO's view these activities generally provide benefits to the market 
and are unlikely to pose risks that will destabilise the market121. 

This option is also in line with the advice of CESR and most responses from market 
participants to the consultation, who consider that market makers and primary market 
dealers  fulfil  an  important  and  legitimate  function  in  providing  liquidity,  and  this 
liquidity would be affected negatively by applying disclosure and other obligations to 
these activities.  

The rationale for this exemption is that when acting as market makers or performing 
primary  market  operations,  these  participants  will  continually  be  required  to  take 
both long and short positions in a large number of financial instruments in order to 
execute  market  making  transactions  to  meet  the  demand  from  market  users  or  to 
perform  their  primary  market  operations.  Their  positions  are  likely  to  change 
continuously  for  each  financial  instrument  and  fluctuate  between  long  positions  to 
short  positions.  It  is  therefore  not  feasible  to  expect  such  activities  to  enter  into 
specific  agreements  for  the  large  number  of  transactions  they  undertake.  To  apply 
such a requirement would make it impossible for these activities to be provided and 
could  have  significant  detrimental  effect  on  markets  including  other  investors  and 
issuers.  

It is difficult to provide detailed estimates of market making activity as increasingly 
traditional  market  makers  are  using  new  automated  trading  methods  for  their 
activities. Also it will vary from trading venue to trading venue. An estimate by one 

121 

IOSCO Final Report on the Regulation of Short Selling, p. 19 
http://www.iosco.org/library/pubdocs/pdf/IOSCOPD292.pdf] 

EN 

52 

   EN 

                                                 
exchange puts the level of market making at 20-25% for the most liquid securities122. 
But  this  is  likely  to  include  some  trading  that  will  not  qualify  for  the  detailed 
definition  of  market  making  activities  in  the  proposal.  Therefore  the  actual  amount 
that is exempted is likely to be significantly less. Further, this is an estimate for the 
most liquid shares, figures for less liquid shares may also be lower. 

This  option  has  the  advantage  that  the  objective  of  reducing  the  risk  of  settlement 
failure  linked  with  naked  short  selling  would  be  met,  while  avoiding  the  possible 
negative  impact  on  liquidity  that  full  application  of  the  proposed  requirements  for 
naked  short  selling  could  have  on  activities  that  are  essential  to  the  efficient 
functioning of markets. In particular, issuers would continue to obtain the benefits of 
liquidity  provision  for  their  financial  instruments  provided  by  market  makers  and 
primary  market  dealers,  and  financial  institutions  providing  this  service  would  be 
able to continue to do so. If appropriate exemptions or adaptations for market making 
activities from the above-mentioned obligations relating to naked short selling were 
not  provided  for,  this  would  have  a  significant  adverse  effect  on  their  ability  to 
provide liquidity to the markets. This would reduce liquidity significantly, resulting 
in  wider  spreads  and  affecting  the  prices  and  the  ability  of  investors  to  purchase 
securities.  This  would  in  turn  have  a  detrimental  effect  on  issuers  of  the  securities. 
the 
Choosing 
proportionality of the measures concerning naked short selling. 

therefore  greatly  contribute 

this  option  would 

to  ensuring 

Similarly  for  certain  primary  market  operations  participants  need  to  take  a  short 
position (for example for stabilisation programmes and the issue of sovereign bonds). 
Failure to provide appropriate exemptions or adaptations would result in direct and 
indirect costs for issuers who wish to raise funds through the issue of securities. 

Another  advantage  of  this  option  is  that  objective  4  would  also  be  achieved,  as  a 
harmonised  exemption  for  market  making,  based  on  a  common  definition,  would 
eliminate  the  scope  for  regulatory  arbitrage  as  all  Member  States  would  have  the 
same  definition.  This  would  also  entail  lower  compliance  costs  than  the  current 
situation where different Member States apply different regimes for market makers. 

This option has the disadvantage that theoretically, uncovered short sales carried out 
for  market  making  activities  may  very  occasionally  result  in  failures  to  settle. 
However, this is unlikely in practice as most short positions for market making are 
held very briefly and the objective of market makers is for these positions to be flat 
at the end of the day. Further, this theoretical risk would be mitigated by excluding 
market  making  activities  and  primary  market  operations  from  the  conditions  on 
naked short selling, while subjecting them to tailored rules for settlement discipline. 
For example, in the United States market makers are subject to buy-in procedures if a 
trade has not been settled 6 days after the trade (T+6), a more lenient period than the 
T+4 foreseen for other market participants. 

The  other  potential  disadvantage  of  this  option  is  that  some  financial  institutions 
might seek to use this exemption to circumvent the requirements on uncovered short 
selling for activities which do not in reality constitute market making. However, this 

122 

London Stock Exchange Group in its response dated 9 July 2010 to the Commission consultation has 
indicated  that  in  Q4  2009  approximately  20-25%  of  trading  in  FTSE  100  shares  was  by  technical 
traders whose strategies may include market making activities.  

EN 

53 

   EN 

                                                 
risk is very limited as only genuine market making activities will be exempted; the 
risk can be mitigated by using the harmonised definition of market making activities 
recommended  by  CESR  and  by  providing  for  the  controls  on  the  use  of  this 
exemption outlined above. In particular, those wishing to benefit from the exemption 
would  have  to  notify  the  competent  authority  in  writing  not  less  than  30  days  in 
advance of their intention to use the exemption, and the competent authority would 
have  the  power  to  obtain  information  from  any  institution  benefiting  from  the 
exemption. 

6.1.2.6  The preferred options 

Option 1 (baseline) 

n.a. 

n.a. 

n.a. 

Impact on stakeholders 

Effectiveness 

Efficiency 

Option 2 
(locate rule) 

Option 3 
(introduce rules on 
settlement discipline) 

Option 4 
(ban on naked short 
selling) 

Option 5 
(exemption for 
market making) 

(+++) regulators will be able to 
sanction naked short selling which 
does not comply with locate rule 
(+++) issuers gain comfort that 
number of shares sold short cannot 
exceed the number issued or available 
to borrow 
(+++) governments gain comfort that 
number of government bonds sold 
short cannot exceed the number issued 
or available to borrow 
(- ) some financial institutions may 
have to adapt their compliance 
systems, although most operate with a 
locate rule currently  

(+++) regulators gain comfort that 
settlement failures will be penalised 
(+++) issuers also obtain reassurance 
that settlement failures will be 
penalised 
(+++) governments – same benefit as 
for issuers, concerning bonds 
(-) financial institutions may face 
penalties or costs due to buy-in 
procedures but prefer this option 

(+++) regulators gain comfort that 
settlement failures due to naked short 
selling will be greatly reduced 
(+++) issuers also obtain reassurance 
that settlement failures due to naked 
short selling will be greatly reduced 
(+++) governments – same benefit as 
for issuers, concerning bonds 
(- - -) financial institutions' ability to 
short sell significantly impaired, 
imposing economic costs and ongoing 
compliance costs 

(-) regulators may have to ensure the 
exemption is not abused 
(+++) issuers and  
(+++) governments gain comfort that 
liquidity in their shares or sovereign 
bonds is not impaired 
(+++) financial institutions: their 
market making activities and primary 
market operations would be exempt 

(++) Objective of reducing 
settlement risk achieved in 
part by rules at the point of 
trading 
(+++) Objective 4: met in 
full 
(+) Contributes to reducing 
risk of negative price spirals 

(-) limited impact in 
terms of ongoing 
compliance costs as 
many already operate 
such a rule; some 
impact on liquidity and 
efficient price 
discovery 

(0 ) limited impact in 
terms of compliance 
costs;  

(- - - ) significant 
negative impact on 
liquidity and efficient 
price discovery and 
economic/compliance 
costs for financial 
institutions 

(+) compliance costs 
would be limited by 
harmonised exemption 
(+++) liquidity 
provided by market 
makers and primary 
market dealers would 
be unaffected 

(++) Objective of reducing 
settlement risk achieved in 
part by strengthening 
settlement discipline 
(+++) Objective 4 : met in 
full 
(+) Contributes to reducing 
risk of negative price spirals 

(++) Objective of reducing 
settlement risk achieved in 
part but settlement failures 
caused by other factors will 
persists 
(+++) Objective 4: met in 
full 
(+) Contributes to reducing 
risk of negative price spirals 

(0) Objective of reducing 
settlement risk unaffected as 
short positions held by market 
makers are briefly held, and 
market makers and primary 
market dealers would be 
subject to settlement 
discipline 
(+++) Objective 4 met in full 
as a harmonised definition of 
a market maker/primary 
market dealer exemption 
would avoid regulatory 
arbitrage and limit 
compliance costs 

EN 

54 

   EN 

 
 
 
 
 
 
Based  on  the  analysis  above,  the  highest  scoring  options  in  terms  of  effectiveness 
and  efficiency  are  options  2  and  3,  while  option  5  scores  highly  in  terms  of 
efficiency.  These  three  options  are  compatible  with  each  other  and  so  could  be 
combined.  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  related  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 makers, and so would the 
potential  for  regulatory  arbitrage  and  compliance  costs  associated  with  different 
exemptions  across  the  EU.  Option  5  would  also  contribute  greatly  to  ensuring  the 
proportionality of the overall approach. 

So the preferred option is a combination of options 2, 3 and 5.  

In  terms  of  scope,  these  options  should  apply  to  shares  and  sovereign  bonds  only, 
consistent with the evidence of the problems raised and the positions expressed in the 
public consultation. However, market makers and primary market dealers should not 
be  exempt  from  rules  on  settlement  discipline;  these  could  be  tailored  to  their 
situation, for example by providing for buy-in procedures for market makers at T+6 
as is foreseen in the United States. 

6.1.3.  Policy  options  to  ensure  regulators  and  markets  obtain  data  on  short  positions 

(including through CDS) 

These  options  will  be  assessed  against  their  effectiveness  in  achieving  the  specific 
objectives  of  ensuring  that  regulators  and  markets  obtain  data  on  short  positions, 
including  through  CDS,  and  reducing  the  scope  for  regulatory  arbitrage  and 
compliance  costs.  These  policy  options  will  also  be  assessed  on  their  efficiency  in 
achieving  these  objectives  for  a  given  level  of  resources  or  at  least  cost  while 
avoiding unduly negative effects on market efficiency. However, options will also be 
assessed against other objectives where appropriate.  

6.1.3.1.  Option 1 – no action at EU level 

Some Member States have already introduced disclosure obligations in the absence 
of  action  at  EU  level,  and  some  others  may  impose  them  based  on  the  CESR 
recommendations,  but  as  explained  in  the  baseline  scenario  this  is  likely  to  be  a 
minority. Therefore this option has the disadvantage that regulators and markets in a 
number of Member States may continue to lack information on short positions. These 
transparency  deficiencies  imply  potential  risks  for  financial  stability,  as  well  as  for 
investor protection and market integrity, because regulators will not be able to detect 
the build-up  of short positions  which may pose risks to orderly markets or be  used 
for market abuse. This option will also mean the continuation of divergent national 
approaches  to  disclosure,  which  leaves  scope  for  regulatory  arbitrage  and  implies 
higher compliance costs for market participants operating in several markets subject 
to different rules. 

EN 

55 

   EN 

 
6.1.3.2.  Option 2 – flagging 

Under this option, a share trading venue would be required to establish procedures to 
ensure  that  persons  entering  short  sale  orders  on  the  trading  venue  would  have  to 
mark  those  orders  as  short  orders.  The  trading  venue  would  then  publish  a  daily 
summary of the volume of short orders. 

This option has several advantages over option 1. It would provide regulators with a 
tool  to  receive  very  precise  information  about  the  volume  of  short  transactions 
relative  to  long  transactions.  This  would  be  very  effective  in  achieving  specific 
objective 2, as it would be very transparent. This option also has advantages over a 
disclosure  regime:  importantly,  according  to  CESR  it  "has  the  potential  to  give 
regulatory  authorities  real-time  data  on  short  selling,  including  intraday  positions, 
and  is  more  suitable  for  micro-supervision  of  transactions"123.  In  addition,  flagging 
could  complement  a  disclosure  regime  by  providing  regulators  with  data  on  short 
positions which remain below any disclosure threshold, and would help regulators to 
enforce  disclosure  rules  by  providing  them  with  a  full  picture  of  the  short 
transactions  of  investors.  By  introducing  a  harmonised  flagging  regime,  this  would 
reduce the scope for regulatory arbitrage, although if implemented in isolation option 
2  would  still  leave  some  scope  for  regulatory  arbitrage,  as  short  positions  obtained 
through OTC derivatives would not be captured by a flagging regime. However, as 
CESR has recognised, it is possible to use flagging in combination with disclosure124. 
Another advantage of this option is that the EU regulatory framework would further 
converge  with  those  of  the  United  States  and  Hong  Kong,  which  both  operate 
flagging regimes. 

The  disadvantage  of  option  2  is  that  the  costs  associated  with  it  are  considered  by 
market  participants  and  some  regulators  to  be  significant.  Compliance  costs  would 
include  the  costs  of  setting  up  the  necessary  IT  systems,  as  well  as  training  and 
compliance procedures. According to estimates received by the UK FSA, the cost of 
a flagging regime could be in a range of several hundreds of thousands of pounds to 
around 2 million pounds for a larger broker, to 20,000 pounds in system costs for a 
small  broker.125  No  detailed  estimates  were  received  as  part  of  the  public 
consultation,  although  some  responses  argued  that  the  costs  would  be  substantial. 
Several  respondents,  including  one  exchange,  stated  that  introducing  a  flagging 
regime  would  require  significant  changes  of  the  complete  European  trading 
infrastructure.  At  the  same  time,  Greece  and  Poland  operate  a  flagging  system  at 
present and the French regulator argued in its response to the public consultation that 
the benefits in terms of increased transparency would outweigh the costs in terms of 
compliance.  

6.1.3.3  Option 3 – notification of significant net short positions to the regulator 

Under this option, short positions would be notified only to the regulator, not to the 
market.  To  ensure  that  only  significant  short  positions  were  notified,  a  threshold 
would  be  introduced  –  CESR  has  proposed  a  threshold  of  0.2%  of  issued  share 

123 
124 
125 

CESR/10-88 (March 2010), p. 6. 
Ibid, p. 6. 
FSA, DP09/1 (February 2009), annex 3, p.7. 

EN 

56 

   EN 

                                                 
capital for notification to regulators126. The related option of whether information on 
short  positions  should  be  notified  in  aggregate  form  is  considered  under  option  5, 
whereas  option  6  considers  the  alternative,  which  is  the  notification  of  individual 
significant net short positions. 

Option 3 has several advantages compared to option 1. It is very effective as it meets 
fully the objective of increasing transparency for regulators in short positions, and is 
an improvement on option 2 as it also includes those short positions obtained through 
CDS, which is to the advantage of governments seeking transparency on sovereign 
CDS. It also achieves the objective of reducing the scope for regulatory arbitrage by 
setting a common EU-wide standard for notification of short positions to regulators. 
This  option  would  therefore  also  entail  lower  compliance  costs  for  financial 
institutions operating in several markets, when compared to the costs of complying 
with the different thresholds for reporting across the EU which currently exist.  

One disadvantage of this option is that the market would not receive the data on short 
positions,  only  regulators.  This  would  mean  that  the  information  asymmetries 
between  short  sellers  and  other  investors  described  in  problem  2  would  persist. 
However,  it  could  be  argued  that  market  participants  are  only  interested  in  data  on 
short  positions  of  a  certain  magnitude,  as  to  receive  data  on  every  short  position, 
however small, would mean processing a lot of data which could be difficult.  

A  second  disadvantage  of  this  option  is  the  cost  of  compliance  and  administrative 
burden on investors. According to the responses received from market participants to 
a  survey  by  DG  Internal  Market,  the  ongoing  costs  of  compliance  with  existing 
national  reporting  obligations  are  estimated  to  be  between  50,000  and  60,000  euro 
per jurisdiction.  

The  impact  on  compliance  costs  could  be  mitigated  if  a  threshold  were  to  be 
introduced for the reporting of positions to the regulator. As indicated above, CESR 
has  proposed  a  threshold  of  0.2%.  Such  a  threshold  would  mean  that  insignificant 
short  positions  would  not  have  to  be  reported,  which  would  exclude  from  the 
obligation those only engaging short selling it to a very limited extent. The burden on 
regulators would also be reduced as they would receive fewer notification and only 
those which reach a sufficient size to be useful for supervisory purposes. 

A  third  disadvantage  is  the  potential  negative  impact  on  market  liquidity.  While 
some  studies  have  suggested  that  disclosure  obligations  have  a  negative  impact  on 
liquidity  (see  section  6.1.2.4.  below),  these  concern  primarily  public  disclosure. 
However, disclosure to the regulator may also inhibit firms from short selling if they 
wish to avoid regulatory scrutiny of their strategies.  

Option  3  is  favoured  by  the  majority  of  market  participants  who  responded  to  the 
public  consultation.  Although  there  were  many  different  views  on  the  levels  and 
instruments to be covered under such an option, there was a significant feeling that 
this would be  preferable  than public  disclosure.  Indeed, respondents also  stated  the 
benefits  this  would  bring  to  regulators,  such  as  the  detailed  information  needed  to 
exercise regulatory duties and, an increased data set to aid the understanding of the 
effects of short selling.  

126 

CESR/10-88 (March 2010), p. 9. 

EN 

57 

   EN 

                                                 
However, some respondents (primarily regulators and non investment firms), as well 
as the association representing the interests of issuers in Europe, argued in favour of 
disclosure of short positions to the market as well as to the regulator. CESR has also 
recommended  a  two-tier  model  for  disclosure  which  combines  disclosure  to  the 
regulator at one threshold with disclosure to the market at a higher threshold, as this 
would "help deter and constrain aggressive short selling which may threaten orderly 
markets or pose the risk of market abuse, and provide early warning signs of a build 
up  of  large  short  positions,  thereby  alerting  regulators  to  potentially  abusive 
behaviour  and  enabling  them  to  monitor  and  take  action  more  effectively127"  (see 
section 6.1.2.4 below).  

6.1.3.4  Option 4 – disclosure of significant net short positions to the market 

Under this option, net short positions would be disclosed to the market as well as to 
the regulator. In addition, it would then need to be decided whether this information 
should be  disclosed in an aggregated  form (see option 5)  or  as individual net short 
positions (option 6). 

Option  4  has  the  same  advantages  as  option  3  –  it  meets  in  full  the  objective  of 
transparency of short positions to the market, including those obtained through CDS, 
and has the same advantages in terms of reducing the scope for regulatory arbitrage 
and compliance costs.  

The  advantage  of  option  4  over  option  3  is  that  it  provides  markets  as  well  as 
regulators  with  transparent  access  to  data  on  short  positions.  According  to  CESR, 
this  provides  informational  benefits  to  the  market,  improving  insight  into  market 
dynamics  and  making  available  important  information  to  assist  price  discovery,  as 
well as providing a more effective potential constraint on aggressive large-scale short 
selling128.  

However,  this  option  also  has  disadvantages.  In  addition  to  the  compliance  costs 
which are of a similar magnitude to those for notification to the regulator, the main 
disadvantage of option 4 is, according to many responses by market participants to 
the public consultation, an adverse impact on market liquidity. This is attributed by 
market  participants  to  concerns  that  if  their  positions  are  disclosed  to  the  market, 
other investors may copy their strategies ('herding behaviour') and this could result in 
them  making  losses  ('short  squeezes');  in  order  to  avoid  this  risk  of  'herding 
behaviour', certain firms might opt not to short sell so as not to have to disclose their 
investment  strategies,  thereby  damaging  liquidity.  However,  CESR  argues  that 
national  regulators  who  operate  public  disclosure  regimes  and  have  undertaken 
empirical  analyses  of  the  impact  of  these  regimes  have  not  seen  these  concerns 
materialise129.  For  example,  the  UK  regulator,  which  instituted  a  temporary  regime 
of  public  disclosure  for  UK  financial  securities,  found  no  evidence  of  phenomena 
such  as  herding  behaviour  or  short  squeezes  occurring  while  the  regime  was  in 
operation.130 

127 
128 
129 
130 

CESR/10-088 (March 2010), p. 5. 
Ibid, p. 6. 
Ibid, p. 8. 
FSA, FS09/3: Short Selling, October 2009, p. 16. 

EN 

58 

   EN 

                                                 
One study of the UK disclosure regime suggests that public short selling disclosure 
obligations reduced short sellers participation in equity markets by 20-25%, and that 
the securities subject to the disclosure regime experienced a 13% decrease in trading 
volumes,  as  well  as  a  widening  of  bid-ask  spreads  of  over  45%131.  However,  the 
results of this study may have been distorted by the comparison of data in a declining 
market in 2008 with data in a benign market from April 2009 onwards, and the wider 
bid-ask spreads on financial stocks may reflect their higher risk at that time. The UK 
Financial  Services  Authority  (UK  FSA)  takes  the  view  that  "while  [a  public 
disclosure  regime]  may  have  some  effect  on  levels  of  short  selling"  they  "do  not 
expect it would do so to any degree that will reduce market quality." Indeed, the UK 
FSA's analysis of stock lending data for the financial securities covered by the public 
disclosure regime levels concluded that levels of short selling were in line with what 
would be expected given underlying market trends132. 

Option 4 was strongly opposed by a significant number of market participants who 
responded to the public consultation, notably banking and investment firms and their 
representative associations, and also to a lesser extent by a limited number of other 
respondents133.  However,  this  option  was  favoured  by  the  association  representing 
the interests of European issuers in their response to the public consultation, on the 
grounds that investor relations departments need to know who is selling shares short 
in  order  to  advise  the  company's  management  on  the  market's  views  of  their 
shares.134 It is also the agreed position of Member State regulators within CESR that 
net short positions above a threshold of 0.5% should be disclosed to the market, as in 
addition  to  the  substantial  informational  benefits  this  option  would  provide  to  the 
market,  it  would  help  to  constrain  particularly  aggressive  large-scale  short  selling 
which may involve unacceptable risks of abuse or disorderly markets135. 

The concerns raised by some market participants could be mitigated by introducing 
thresholds  for  reporting  to  the  regulator  and  to  the  market,  so  that  only  significant 
short  positions  of  a  certain  magnitude,  exceeding  a  certain  threshold,  would  be 
disclosed.  CESR  recognises  that  the  efficacy  and  compliance  burden  of  such  a 
disclosure regime would depend on the levels of such thresholds, and that it would 
not provide a complete picture of the overall levels of shorting as investors may limit 
their  short  transactions  in  order  to  remain  below  the  disclosure  threshold136. 
Nevertheless,  they  conclude  that  the  benefits  of  having  harmonised  uniform 
thresholds outweigh the disadvantages137. As outlined above, CESR has proposed a 
threshold of 0.2% for notification to the regulator, and of 0.5% for disclosure to the 

131 

132 
133 
134 

135 
136 

137 

Oliver Wyman Inc, The effects of short selling public disclosure regimes on equity markets, 2010, pp. 
4-5. 
FSA, FS09/3: Short Selling, October 2009, p. 16. 
AIMA, BBA, ISDA, ISLA, AFME, Dutch Ministry of Finance, Danish Central Bank and VW group. 
EuropeanIssuers,  Response  to  European  Commission's  Public  Consultation  on  Short  Selling,  9  July 
2010, p. 3. 
CESR/10-088 (March 2010), p. 8. 
CESR/10-088  (March  2010),  p.  8.  Also,  in  their  joint  response  to  the  public  consultation,  the 
Association of Financial Markets in Europe, (AFME) the International Securities Lending Association 
(ISLA) and the International Swaps and Derivatives Association (ISDA) stated that their prime broker 
member  firms  had  "confirmed  that  their  clients  avoid  short  selling  beyond  disclosure  thresholds  to 
avoid signalling their trading strategies to the broader market" (p. 8). 
CESR/10-088 (March 2010), p. 9.  

EN 

59 

   EN 

                                                 
market138. A disadvantage of having thresholds is that short positions held just below 
those thresholds would not be disclosed, but if this option were to be combined with 
option 2, regulators would still have access to data on these short positions. 

Option  4  could  also  be  combined  with  option  5  and  data  could  be  disclosed  to  the 
market only on an aggregated basis, an option supported by several associations of 
market participants139 (see section 6.1.2.5 below). However, combining these options 
would not provide the degree of transparency sought by issuers and would not have 
the same effect of discouraging aggressive short selling. 

6.1.3.5  Option 5 – aggregated disclosure of net short positions 

Under this option, short positions would not be disclosed individually, but would be 
compiled  by  the  regulator  and  disclosed  to  the  market  on  an  anonymous  basis:  the 
total size of short positions held in a financial instrument would be made public, but 
not the identity of the individual institutions which held those short positions.  

This option has the advantage that it would partially meet the objective of increasing 
transparency in short positions, including through CDS, and it would also meet the 
objective of reducing the scope for regulatory arbitrage and compliance costs through 
a  common  EU  approach  to  disclosure.  For  short  sellers  themselves,  it  has  the 
advantage that their individual short positions would not be disclosed, which might 
make them less likely to reduce their levels of short selling (for the reasons explained 
in the analysis of option 4 above), which would mean their contribution to liquidity 
in the instruments concerned would be less affected.  

On  the  other  hand,  CESR  considers  that  the  fact  that  individual  positions  would 
remain  anonymous  would  make  this  option  less  effective  as  a  constraint  on 
aggressive short selling140, and so this option would not contribute to achieving the 
objective of reducing the risk of negative price spirals. 

This option has other disadvantages: the degree of transparency would be less than 
that provided by the disclosure of individual short positions (option 6), so issuers and 
other  market  participants  would  not  know  which  individual  institutions  held 
significant short positions in specific financial instruments, which could be valuable 
information  for  them  in  formulating  their  business  or  investment  strategies. 
Furthermore, regulators would have to process the data received in order to publish it 
in  aggregated  form,  thereby  imposing  administrative  costs  on  them.  Financial 
institutions would also still face compliance costs to disclose.  

Further, when compared to option 1, option 5 has the disadvantage that EU Member 
States which currently require disclosure of individual short positions would have to 

138 

139 

140 

Ibid,  p.  9.  These  thresholds  were  decided  following  a  public  consultation,  an  informal  survey  by  one 
regulator  and  discussions  with  all  regulators.  CESR  considers  that  the  public  disclosure  threshold 
should be higher than that introduced by many regulators in 2008 as it would apply to all shares, not 
just  financial  sector  shares,  and  the  lower  threshold  for  reporting  to  the  regulator  would  mean  that 
regulators would already have had advance notice of building short positions in the issued share capital 
of a particular issuer and would already have had the opportunity to consider their response. 
Alternative  Investment  Managers  Association,  European  Commission's  Public  Consultation  on  Short 
Selling, 13 July 2010, p. 2. Also AFME, ISLA and ISDA, p. 7. 
CESR/10-088 (March 2010), p. 6. 

EN 

60 

   EN 

                                                 
reduce  the  level  of  transparency  by  switching  to  aggregated  disclosure.  While  this 
may be welcomed by institutions engaged in short selling themselves, the regulators 
and other market participants in the concerned Member States may not welcome this 
reduction in the level of transparency that they have become accustomed to.  

Most market participants who responded to the consultation favoured this option. In 
contrast, national regulators have agreed in CESR on a disclosure model based on the 
disclosure of significant individual net short positions (see option 6). 

6.1.3.6  Option 6 – disclosure of significant individual net short positions 

Under  this  option,  individual  short  positions  would  be  notified  on  a  net  basis  (i.e. 
short  positions  would  be  subtracted  from  long  positions).  A  threshold  would  be 
introduced so that only significant net short positions would be disclosed. CESR has 
proposed a threshold of 0.5% of the issued share capital. 

This  option  is  a  significant  improvement  on  options  1  and  5.  It  fully  meets  the 
objective of transparency by providing regulators or the public with data not just on 
short  positions,  but  also  which  institutions  hold  those  short  positions.  Unlike  the 
baseline  scenario  or  option  5,  under  this  option  issuers  gain  full  access  to  data  on 
which institutions may hold short positions in their financial instruments, and other 
market participants can adjust their investment strategies based on a complete picture 
of who holds significant short positions at any given time. Option 6 also fully meets 
the objective of reducing the scope for regulatory arbitrage as short positions through 
the use of derivatives are captured and a common disclosure regime would apply to 
all  Member  States.  This  would  also  mean  lower  compliance  costs  for  market 
participants compared to option 1. 

The  main  disadvantage  of  this  option,  as  explained  above,  is  that  financial 
institutions  may  reduce  their  levels  of  short  selling  in  order  to  avoid  disclosure  of 
their  investment  strategies  to  the  market, and  this  could  have  a  negative  impact  on 
liquidity.  However,  this  could  be  mitigated  by  providing  for  a  threshold  for 
disclosure to the market. 

6.1.3.7  Option 7 – exemption from disclosure requirements for market making activity and 

primary market operations 

Under this option, market making activities and primary market operations would be 
exempt from the disclosure requirements and the flagging requirement. The content 
and conditions for the exemption are as described in section 6.1.2.5. 

As  explained  in  section  6.1.2.5  above,  the  rationale  for  this  exemption  is  that 
liquidity provided by market making activity is critical to the efficient functioning of 
markets,  especially  for  less  liquid  securities.  CESR  has  proposed  an  exemption  for 
market making activities in their model for a pan-European short selling disclosure 
regime  because,  in  order  to  be  able  to  provide  liquidity  on  demand  throughout  the 
day, market makers regularly have to take short positions, generally temporary ones, 
and may be at risk of unjustified commercial prejudice if those positions are known 

EN 

61 

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to  the  market.  CESR  recommends  that  the  exemption  should  be  in  relation  to  both 
notification to the regulator and disclosure to the market141. 

This  option  is  also  in  line  with  most  responses  from  market  participants  to  the 
consultation  (see  section  6.1.2.5),  who  consider  that  market  makers  and  primary 
market dealers fulfil an important and legitimate function in providing liquidity, and 
this  liquidity  would  be  affected  negatively  by  applying  disclosure  and  other 
obligations to these activities. Further, publication of information about positions at 
the  end  of  the  trading  day  would  be  of  limited  informational  value  to  competent 
authorities or even misleading as it would only provide a snapshot of an arbitrary and 
fleeting position.  

This  option  has  the  advantage  that  the  objective  of  increasing  the  transparency  of 
short selling would be met, while avoiding the possible negative impact on liquidity 
that  full  application  of  the  proposed  transparency  requirements  could  have  on 
activities  that  are  essential  to  the  efficient  functioning  of  markets.  In  particular, 
issuers would continue to obtain the benefits of liquidity provision for their financial 
instruments  provided  by  market  makers  and  primary  market  dealers,  and  financial 
institutions  providing  this  service  would  be  able  to  continue  to  do  so.  At  the  same 
time, short selling carried out for speculative or hedging purposes would be captured 
by reporting or disclosure obligations, but not short positions carried out for market 
making or primary market operations. 

Another  advantage  of  this  option  is  that  objective  4  would  also  be  achieved,  as  a 
harmonised  exemption  for  market  making,  based  on  a  common  definition,  would 
eliminate  the  scope  for  regulatory  arbitrage  as  all  Member  States  would  have  the 
same  definition.  This  would  also  entail  lower  compliance  costs  than  the  current 
situation where different Member States apply different regimes for market makers. 

This  option  has  the  disadvantage  that  regulators  or  the  market  may  lose  access  to 
some  data  that  they  may  occasionally  consider  to  be  useful.  However,  this  risk  is 
mitigated  by  the  fact  that  competent  authorities  can  require  any  data  they  consider 
necessary from any market participant using the exemption.  

The  other  potential  disadvantage  of  this  option  is  that  some  financial  institutions 
might  seek  to  use  this  exemption  to  circumvent  the  transparency  requirements  for 
activities which do not in reality constitute market making. However, this risk is very 
limited  and  can  be  mitigated  by  using  the  harmonised  definition  of  market  making 
activities recommended by CESR and by providing for the controls on the use of this 
exemption outlined above. In particular, those wishing to benefit from the exemption 
would  have  to  notify  the  competent  authority  in  writing  not  less  than  30  days  in 
advance of their intention to use the exemption, and the competent authority would 
have  the  power  to  obtain  information  from  any  institution  benefiting  from  the 
exemption. 

6.1.3.8  The preferred options 

Option 1 (baseline) 

n.a. 

n.a. 

n.a. 

Impact on stakeholders 

Effectiveness 

Efficiency 

141 

CESR/10-088, pp. 10-11. 

EN 

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   EN 

 
                                                 
(- - ) compliance costs 
for financial 
institutions  

(+++) Objective 2: very 
transparent, captures 
intraday positions 
(++ ) Objective 4: partially 
met, but this option in 
isolation would not capture 
short positions through OTC 
derivatives 

(+++) Objective 2:fully met 
for regulators 
(+++) Objective 4: fully 
met;, better than option 2 as 
short positions through 
derivatives are captured 

(- ) ongoing 
compliance costs; 
could reduce market 
liquidity 

(+++) Objective 2:fully met 
for market 
(+++) Objective 4: fully met 

(- -) ongoing 
compliance costs; more 
likely to reduce market 
liquidity than option 3 

(+) Objective 2: partially met, 
less detailed transparency 
than option 6 
(+) Objective 4: met, but at 
cost of reduced transparency 
for some Member States 

(- )ongoing compliance 
costs, but lower impact 
on liquidity  

(+++) Objective 2: met in 
full  
(+++) Objective 4: met in 
full 

(- -) ongoing 
compliance costs, more 
likely to reduce market 
liquidity than option 5 

Option 2 
(flagging) 

Option 3 
(notification of short 
positions to 
regulator) 

Option 4 
(disclosure of short 
positions to the 
market) 

Option 5 
(aggregated 
disclosure of net 
short positions) 

Option 6 
(disclosure of 
individual significant 
net short positions) 

(+++) regulators obtain very precise 
information on short vs. long 
transactions, which captures intraday 
positions and aids enforcement 
(+++) governments comforted by 
regulators access to real time data 
(0) issuers – no obvious costs or 
benefits 
(0) individual investors – as above 
(- -) financial institutions bear 
compliance costs  

(+++) regulators obtain data on short 
positions they currently lack 
(- - -) issuers do no have access to data 
on short positions in their shares 
(- - -) individual investors - information 
asymmetries persist 
(+++) governments gain comfort that 
regulators obtain data on short 
positions through CDS 
(- ) financial institutions face 
compliance costs to notify and may 
reduce levels of short selling 

(+++) regulators obtain data on short 
positions they currently lack 
(+++) issuers obtain access to data on 
short positions in their shares 
(+++) individual investors - 
information asymmetries eliminated 
(+++) governments gain comfort that 
regulators obtain transparency on 
short positions through CDS 
(- - -) financial institutions face 
compliance costs to disclose and likely 
to reduce levels of short selling 

(+) regulators have access to data on 
short positions but have to process it in 
order to publish it in aggregated form 
(+) issuers obtain less specific data on 
who holds short positions in their 
shares 
(+) individual investors see partial 
reduction in information asymmetries 
(++) governments gain transparency 
on short positions through CDS, but 
some may lose out if they currently 
require individual disclosure 
(- -) financial institutions still face 
compliance costs to disclose, but less 
likely to reduce levels of short selling 

(+++) ensures regulators obtain full 
transparency 
(+++) issuers obtain full transparency 
(+++) individual investors informed of 
short sellers' strategies  
(+++) governments obtain full 
transparency on short positions 
through CDS 
(- - -) financial institutions face 
compliance costs and may reduce 
levels of short selling to avoid 
disclosure of their positions 

Option 7 
(exemption for 
market making and 
primary market 
operations) 

(-) regulators may lose some useful 
data or face risk of abusive use of 
exemption 
(+++) issuers obtain full benefits of 
liquidity provision by market makers 

(++) Objective 2 partially 
met as all short selling 
captured except when it is 
carried out by legitimate 
market makers 

(+++) liquidity 
provided by market 
makers and primary 
market dealers not 
affected 

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   EN 

 
 
and can use short selling for 
stabilisation 
(+++) individual investors also benefit 
from ease of buying and selling at 
efficient price 
(+++) governments gain comfort that 
liquidity in sovereign bond markets is 
not impaired 
(+++) financial institutions engaged in 
bona fide market making can continue 
their activities  

(+++) Objective 4 fully 
achieved as exemption would 
be harmonised at EU level 
(+++) General objective of 
avoiding unduly negative 
effects on market efficiency 
achieved 

Based on the analysis above, the highest scoring options are options 2, 3, 4, 6 and 7. 
All these options are compatible. In fact, a combination of these five options would 
address some of their individual shortcomings. In particular, option 3 only provides 
transparency  to  regulators,  whereas  option  4  provides  transparency  also  to  the 
market. By combining these two options, using one threshold for notification to the 
regulator and a second, higher threshold for notification to the market, the objective 
of  transparency  for  both  would  be  achieved.  In  addition,  the  higher  threshold  for 
notification to the market would mitigate any impact on liquidity that disclosure at a 
lower  threshold  might  have,  while  ensuring  that  regulators  obtain  the  data  they 
require. Combining these two options in this way also has the advantage of being in 
line with the disclosure model drawn up by CESR. The option of requiring disclosure 
of  individual  significant  net  short  positions  (option  6)  should  be  preferred  to 
aggregated disclosure (option 5), as it meets the objectives more fully by providing 
the market with more detailed transparency. Combining option 2 (flagging) with the 
disclosure options would complement these very effectively by potentially providing 
regulators  with  real  time  data  on  all  short  positions,  not  just  those  above  the 
threshold,  thereby  helping  regulators  with  enforcement,  and  would  also  capture 
intraday  positions  which  would  not  be  captured  by  a  disclosure  regime.  Finally, 
opting for an exemption for market making activities and primary market operations 
(option  7)  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  a  disclosure  regime.  Inclusion  of  this  option  will  greatly  contribute  to 
ensuring the proportionality of the overall approach. 

So the preferred option is a combination of options 2, 3, 4, 6 and 7. 

With regard to the legal scope of the transparency regime, this should apply to shares 
and  their  derivatives,  including  CDS.  However,  with  regard  to  bonds,  the  public 
consultation  showed  very  limited  support  for  the  inclusion  of  corporate  bonds  and 
their derivatives in a disclosure regime, and therefore these should be excluded. With 
regard to sovereign bonds and their derivatives, including CDS, there was support for 
their inclusion by public authorities, but serious concerns were expressed about the 
potential  negative  impact  on  liquidity  of  public  disclosure  of  sovereign  bond  and 
sovereign  CDS  short  positions.  Therefore  the  disclosure  of  sovereign  bonds  and 
sovereign CDS should be limited to regulators only. This scope is consistent with the 
evidence  of  problems  and  concerns  raised  by  governments,  regulators  or  issuers  of 
transparency  deficiencies;  it  is  therefore  also  consistent  with  the  principle  of 
proportionality.  The  public  consultation  showed  very  limited  support  for  other 
instruments to be captured in a disclosure regime.  

EN 

64 

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An  important  issue  of  geographical  scope  also  arises  in  the  context  of  disclosure. 
Transactions in shares or sovereign debt admitted to trading on a trading venue in the 
EU can also take place outside the EU, and if such transactions are not captured by 
the  disclosure  regime,  this  could  be  circumvented.  Therefore  for  this  regime  to  be 
effective, it is important that notification and disclosure obligations apply no matter 
where a transaction takes place, including where it takes place outside the Union but 
in  relation  to  a  company  or  sovereign  debt  issuer  that  has  shares  or  sovereign  debt 
admitted to trading on a trading venue in the Union.  

6.2. 

The preferred policy options and instrument 

6.2.1.  The preferred policy options  

Based on the above analysis of the impacts, the preferred policy options to achieve 
the objectives set out in this impact assessment are the following: 

Reduce  the  risks  of  negative  price  spirals  arising  from  short  positions  (including 
those obtained through CDS) 

•  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'). 

•  grant national competent authorities the power to temporarily restrict or ban short 
selling  of  some  or  all  financial  instruments  or  CDS  transactions  in  exceptional 
situations, with coordination by ESMA and without prejudice to ESMA's powers 
under article 10 of Regulation ??/EC establishing ESMA).  

Increase the transparency of short positions (including those obtained through CDS) 

•  introduce a flagging system. 

•  notification of short positions to the regulator at a threshold of 0.2%.  

•  disclosure of short positions to the public at a threshold of 0.5%.  

•  disclosure of individual significant net short positions.  

•  exemption from disclosure requirements for market makers.  

Reduce settlement risk linked with 'naked' short selling 

•  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 which ensure that he will be able to borrow the share at the time of 
settlement (locate rule) 

•  introduce EU rules on settlement discipline so that persons engaging in short sales 
which  result  in  a  failure  to  deliver  face  appropriate  penalties,  with  buy-in 
procedures and fines in case of settlement failures 

EN 

65 

   EN 

•  exemption  for  market  makers  from  the  locate  rule,  but  not  from  the  buy-in 

procedures.  

6.2.2.  Choice  of  instrument  to  ensure  a  coordinated  response  by  EU  Member  States  to 

short selling and CDS 

6.2.2.1  Non-legislative  cooperation  between  Member  States  with  guidelines  by 

CESR/ESMA 

One  option  to  achieve  the  objectives  set  out  in  this  report  would  be  through 
cooperation  between  governments  and  regulators  in  the  EU  Member  States, 
coordinated  through  CESR  and  in  future  through  ESMA.  This  is  to  some  extent 
already  happening,  as  national  regulators  have  discussed  and  agreed  in  CESR  on  a 
model  for  a  two-tier  short  selling  disclosure  regime,  and  CESR  has  advised 
regulators to implement this model pending possible action at EU level. CESR is also 
working  on a model for  disclosure to  regulators  for  sovereign bonds and sovereign 
CDS. If all Member States were to voluntarily implement these models based on the 
work  of  CESR,  this  would  go  a  long  way  towards  addressing  the  objective  of 
ensuring that regulators and markets obtain data on short positions, including those 
obtained through CDS. 

However, the disadvantage of this approach is that it is voluntary, and Member States 
may opt not to implement the CESR model at national level. In the absence of EU 
legislative action, there would be no obligation on Member States to implement this 
transparency  regime,  and  the  Commission  would  not  be  able  to  take  infringement 
action  against  Member  States  that  did  not  act,  or  which  took  a  different  approach 
than that proposed by CESR/ESMA. 

The  divergent  responses  taken  by  Member  States  to  short  selling  in  exceptional 
situations also illustrate the limits of non-legislative cooperation. Member States are 
not required to consult and cooperate with each other before introducing exceptional 
measures,  which  leaves  wide  scope  for  unilateral  actions  to  be  taken  without  prior 
consultation. In the absence of a European legislative framework, the effectiveness of 
national actions is also open to question, as there is no obligation on Member States 
to cooperate with each other, and the absence of such cooperation leaves scope for 
regulatory arbitrage.  

Concerning the policy options to reduce potential settlement risks arising from naked 
short  selling,  cooperation  between  Member  States  also  has  limited  effectiveness.  It 
has  not  been  possible  for  Member  States  to  agree  on  a  common  approach  to  the 
regulation of naked short selling, with some Member States having a permanent ban 
(e.g.  Spain)  and  others  introducing  temporary  bans  (e.g.  France  and  Germany). 
Trading  venues  and  Member  States  also  take  different  approaches  to  the  issue  of 
settlement discipline. 

Last but not least, the European Commission has opted in its Work Programme for 
2010 to present a legislative initiative on short selling and Credit Default Swaps. In 
view  of  the  disadvantages  outlined  above,  the  option  of  promoting  non-legislative 
cooperation  between  Member  States  with  guidelines  by  CESR/ESMA  is  therefore 
not the most effective and efficient instrument to achieve the objectives set out in this 
impact assessment.  

EN 

66 

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6.2.2.2  Propose  new  stand-alone  EU  legislation  on  short  selling  in  a  Directive  or  a 

Regulation 

Having discarded the option of a non-legislative instrument, this leaves the options of 
pursuing  the  objectives  of  this  impact  assessment  through  a  harmonising  legal 
instrument.  A  harmonising  legal  instrument  would  ensure  that  all  Member  States 
applied the same regulatory framework based on the same principles, thereby ending 
the current fragmentation of the regulatory response to short selling and ensuring that 
compliance  costs  would  be  lower.  However,  it  is  necessary  to  define  whether  the 
appropriate legal instrument should be a Directive or a Regulation. 

Traditionally,  the  main  legislative  instrument  chosen  for  EU  financial  services 
legislation  has  been  a  Directive.  This  was  because  the  legislative  proposals  mainly 
sought to approximate national rules on the taking up of business and the provision 
of services in a gradual manner. The choice of a Directive enables Member States to 
integrate  rules  into  their  different  legal  systems,  while  allowing  some  margin  for 
them to extend EU rules to areas uncovered by the EU legislation.  

However, a Directive does not seem to be the right choice of instrument in view of 
the  objectives  of  this  initiative  for  a  number  of  reasons.  A  Directive  would  leave 
some  scope  for  Member  States  to  maintain  divergent  rules,  whereas  a  Regulation 
would ensure uniform rules throughout the EU. Nevertheless, a Regulation can leave 
some  flexibility  for  national  competent  authorities  in  applying  the  rules.  While  a 
Directive requires national implementing provisions to be adopted, leaving scope for 
interpretation of the Directive, a Regulation is directly applicable without requiring 
national legislation, thereby ensuring  greater legal certainty for those subject to the 
legislation.  

Implementation  of  a  Directive  into  national  law  can  also  be  a  time  consuming 
process.  In  contrast,  a  Regulation  is  immediately  applicable  after  adoption  by  the 
legislator and, while it is likely to require binding technical standards to be adopted 
through delegated acts in certain areas to ensure consistent application, these can be 
prepared  in  parallel  to  the  process  for  adoption  of  the  legislation.  Further,  a 
regulation  does  not  require  any  monitoring  of  correct  implementation  by  the 
Commission, and those concerned by the provisions of a Regulation would be able to 
depend  on  them  immediately.  Finally,  a  Regulation  could  be  directly  invoked  by 
concerned  parties  before  national  administrations  and  courts,  whereas  this  applies 
only in very limited circumstances for Directives.  

For all these reasons, the Commission services consider that a Regulation rather than 
a Directive the most appropriate instrument for this initiative.  

6.2.3. 

Impact on retail investors and SMEs 

Given  that  it  is  a  highly  risky  investment  strategy,  short  selling  is  unlikely  to  be 
widely used by retail investors, so to the extent that this initiative may restrict levels 
of short selling, retail investors will not be significantly affected in a negative sense. 
However,  retail  investors  would  benefit  from  the  enhanced  transparency  of  short 
selling transactions, as they would have a clearer picture as to the reasons why some 
investors  are  selling  certain  securities,  and  could  either  emulate  those  strategies  or 
decide to hold their securities in the knowledge that prices might rebound when short 

EN 

67 

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sellers closed their positions. Retail investors would also benefit from the enhanced 
stability of markets which coordinated national responses to short selling could bring 
at  times  when  markets  are  distressed.  Retail  investors  also  benefit  from  a  highly 
liquid  market,  so  the  option  to  exempt  market  making  activities  would  help  to 
preserve liquidity and make it easier for retail investors to buy and sell securities at 
efficient prices. The options which reduce the risk of settlement failure would also be 
to  the  advantage  of  retail  investors,  as  they  would  face  a  lower  risk  that  securities 
they had bought from a short seller would not be delivered in due time.  

Shares in SMEs are unlikely to be subject to short selling as these are generally much 
less  liquid  markets,  so  small  and  medium  sized  issuers  would  not  be  substantially 
impacted by restrictions on short selling. However, SMEs as investors would obtain 
similar benefits to those outlined for retail investors above. 

6.2.4. 

Impact on third countries  

This  initiative  will  impact  on  third  countries  in  two  main  ways.  As  explained  in 
section  6.1.2,  it  is  proposed  that  in  order  for  them  to  be  effective,  notification  and 
disclosure  obligations  should  apply  no  matter  where  a  transaction  takes  place, 
including  where  it  takes  place  outside  the  EU  but  in  relation  to  a  company  or 
sovereign  debt  issuer  that  has  shares  or  sovereign  debt  admitted  to  trading  on  a 
trading  venue  in  the  EU.  If  this  were  not  to  be  the  case,  it  would  be  possible  for 
investors to circumvent the disclosure obligations by engaging in transactions in third 
countries, either over the counter or (where securities are listed in third countries) on 
trading  venues  in  those  countries.  The  public  consultation  showed  strong  support 
from  most  respondents  and  from  public  authorities  for  the  application  of  the 
disclosure  regime  to  extend  to  both  persons  within  and  outside  the  EU  who  have 
significant net short positions in EU shares or EU sovereign bonds. 

This implies that investors or firms which are outside the EU will have to notify, to 
the regulator of the most liquid market in the EU for the share or sovereign bond, or 
disclose to the market, short positions which exceed the relevant thresholds. In order 
to  enforce  this  requirement,  EU  regulators  should  be  required  by  the  short  selling 
legislation  to  upgrade  existing  international  agreements  (e.g.  the  IOSCO  MoU)  or 
reach further cooperation agreements with regulators in the third countries where EU 
shares  or  sovereign  bonds  are  mainly  traded.  Such  agreements  should,  inter  alia, 
provide  for  exchanges  of  information  with  regulators  in  third  countries  so  as  to 
ensure  that  that  concerned  investors  in  those  countries  are  made  aware  of  their 
obligations with regard to the EU legislation and comply with them. EU regulators 
could in specific cases exchange information with third country regulators to enforce 
the obligations in EU short selling legislation, as well to take reciprocal action in an 
exceptional  situation.  ESMA  could  be  required  to  facilitate  such  cooperation  by 
preparing a template agreement that could be used by national competent authorities. 
These  authorities  should  also  be  required  to  inform  ESMA  when  they  propose  to 
enter  into  an  agreement  with  a  third  country  regulator.  This  approach  would  be 
proportionate since by upgrading existing agreements and using an ESMA template 
Member States would be able to limit the costs of reaching cooperation agreements 
with third countries. 

At  the  same  time,  it  is  foreseen  that  this  initiative  would  not  apply  to  shares  for 
which,  while  they  may  be  admitted  to  trading  on  a  trading  venue  in  the  EU,  their 

EN 

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principal  market  is  located  outside  the  EU.  This  reflects  that  fact  that  shares  in 
companies  are  increasingly  traded  on  a  number  of  different  trading  venues  around 
the world. For example, many large overseas companies have shares traded not only 
on  their  home  market  but  on  a  trading  venue  in  the  European  Union.  It  is  not 
appropriate or proportionate to apply short selling requirements where most trading 
of  the  share  takes  place  outside  the  Union.  This  is  potentially  onerous  for  market 
participants  and  creates  unnecessary  complexity  that  may  discourage  issuers  from 
having their shares traded on venues in the European Union. 

In order to facilitate implementation of this provision by investors, ESMA should be 
notified at least every two years by national regulators of which shares fall into this 
category, and ESMA would then publish a list of those shares.  

leaves  scope  for 

The  fact  that  the  legal  framework  on  short  selling  can  diverge  across  different 
countries 
international  regulatory  arbitrage,  especially  for 
instruments  which  are  not  traded  on  a  regulated  trading  venues.  In  particular,  the 
trading of sovereign bonds and credit default swaps is almost exclusively done over 
the  counter,  and  can  therefore  move  very  easily  from  one  jurisdiction  to  another. 
International  regulatory  cooperation  through  fora  such  as  IOSCO  is  therefore  very 
important  in  this  area,  and  the  European  Union  should  take  a  lead  in  enhancing 
cooperation with its main international partners.  

The  proposed  initiative  on  short  selling  aims  at  introducing  greater  coordination  in 
Europe  in  the  regulation  of  financial  markets.  As  such,  it  could  contribute  to  more 
integrated financial markets in Europe. Similarly to the effect of the single currency, 
this  further  integration  could  have  the  effect  of  enhancing  the  global  nature  of 
European 
relative 
competitiveness compared to third countries, notably the United States. 

financial  markets,  which  could 

increase 

their 

turn 

in 

The  preferred  options  retained  in  this  impact  assessment  would  ensure  that  the 
European Union's regulatory regime would converge with that of the United States, 
which  already  operates  a  flagging  regime,  circuit  breaker,  a  disclosure  regime,  a 
locate rule and buy-in procedures in case of settlement failures.  

6.2.5. 

Social impact 

To  the  extent  that  the  options  considered  in  this  initiative  will  help  to  contain  the 
effects of future financial crises on the real economy, they will also help reduce the 
social costs of those crises (e.g. unemployment). 

6.2.6.  Environmental impact 

It does not appear that the options proposed in this will have any direct or  indirect 
impacts on environmental issues.  

6.3. 

Estimate of impact in terms of compliance costs 

The  preferred  options  include  requirements  for  firms  to  ensure  regulators  and 
markets  obtain  data  on  short  positions  (including  CDS)  by  notification  of  short 
positions to the regulator and by disclosure of short positions to the public. As part of 
this  option,  regulators  would  be  expected  to  provide  quarterly  reports  to  ESMA  on 
the  net  short  positions  notified  or  disclosed  within  their  jurisdiction.  This  section 

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provides  an  estimate  of  the  compliance  costs  (including  both  one-off  and  ongoing 
costs)  implied  by  these  requirements.  The  full  explanation  of  the  methodology, 
assumptions and calculation of the estimate can be found in annex 8.  

This  section  also  provides  an  indication  of  the  order  of  magnitude  of  the  cost  of 
disclosure of significant short positions in sovereign bonds which is also part of the 
preferred options. A more comprehensive assessment of the compliance cost of this 
approach has not proved possible due to the absence of data, since no Member State 
has such a disclosure regime at national level and no Member State has been able to 
provide estimates for the cost of such a reporting regime. 

For  some  options  assessed  in  this  report  it  has  not  proved  possible  to  carry  out  a 
detailed  estimate  of  the  compliance  costs  for  the  EU  as  a  whole.  This  estimates  of 
compliance costs in this section do not include the costs of flagging, because other 
than the estimates provided by the UK FSA (see section 6.1.2.2), no cost estimates 
have  been  submitted  to  the  Commission  services  despite  repeated  requests  for  data 
from  regulators  and  market  participants.  The  analysis  of  the  flagging  option 
acknowledges  that  the  costs  of  this  option  could  be  significant,  but  also  that  this 
option would offer benefits in terms of increased transparency. 

Finally,  the  Commission  services  have  not  received  from  market  participants 
estimates  of  compliance  costs  for  the  locate  rule  option.  However,  as  explained  in 
section  6.1.3.2,  the  costs  of  a  locate  rule  would  be  limited  since  most  market 
participants indicated to the Commission that they currently apply a locate rule as a 
matter of good business practice.  

According  to  our  estimation,  the  main  part  of  the  compliance  costs  related  to 
notification  and  disclosure  requirements  would  consist  in  a  one-off  investment  in 
information  technology  and  information  systems  (IT/IS)  development,  training  and 
compliance  procedures.  We  estimated  the  number  of  banks  and  investment  firms 
with  sufficiently  large  operations  to  be  likely  to  have  to  disclose  (based  on  data  of 
existing  disclosure  regimes  provided  by  6  Member  States).  We  then  assumed  that 
10%  of  these  firms  would  be  large,  complex  cross-border  institutions  reporting 
across  most  EU  jurisdictions,  with  the  remaining  90%  of  firms  mainly  reporting in 
one jurisdiction.  

Based on estimates provided by some market participants we estimated the average 
one-off costs in terms of IT/IS development, training and compliance procedures for 
complying  with  disclosure  obligations  for  these  two  types  of  firms.  We  therefore 
estimate the EU-wide one-off costs in terms of compliance costs to be approximately 
137  million  euro.  We  estimate  ongoing  costs  to  maintain  or  upgrade  IT/IS  on  a 
yearly basis to be 10% of this cost, or approximately 13.7 million euro. 

In order to estimate the ongoing costs in terms of disclosure to the regulator when the 
relevant  threshold  is  exceeded  and  to  the  public  when  the  higher  threshold  is 
exceeded,  we  examined  data  provided  by  6  Member  States  on  the  number  of 
disclosures received in their current national disclosure regimes. Since these regimes 
are  based  on  disclosure  of  significant  short  positions  only  in  shares  of  financial 
institutions, we then extrapolated from this  data  to obtain an estimate of the yearly 
average  number  of  disclosures  for  all  shares.  We  also  grouped  Member  States  into 
three  categories  according  to  the  likely  frequency  of  disclosures  per  year:  high, 

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medium  and  low.  Since  these  estimates  do  not  take  into  account  the  multiple 
thresholds foreseen in the preferred disclosure option, these estimates were adjusted 
based on estimates for the frequency of disclosures at different thresholds provided 
by the UK.  

We then estimated the yearly number of disclosures for each category based on the 
data available from 6 Member States. We estimated the average time it would take to 
produce one disclosure as 2 hours. Given that a large proportion of notifications are 
likely  to  be  made  by  complex  cross-border  entities,  often  with  a  centralised 
compliance function in a high wage cost country, we thought it appropriate to apply 
an  average  hourly  wage  for  managers  from  a  large  Member  State  (in  this  case  the 
UK).  We  then  estimated  the  costs  per  Member  State  of  disclosure  based  on  the 
estimated average number of disclosures.  

As a result of the preceding analysis, we therefore estimate that the ongoing costs for 
disclosure of short positions in shares to be approximately 2.1 million euro per year. 
To this should be added the estimate of ongoing IT/IS costs of 13.7 million euro per 
year.  Therefore  the  annual  EU-wide  compliance  cost  (not  including  one-off  costs) 
could be estimated to be approximately 15.8 million euro. 

For  the  administrative  cost  on  regulators  of  quarterly  reporting  to  ESMA  of 
significant  net  short  positions  in  their  jurisdiction,  we  also  assumed  that  compiling 
each  quarterly  report  would  take  2  hours.  Based  on  the  average  hourly  wages  of 
managers in the 27 Member States, this gives an estimated total administrative cost 
for regulators in the EU 27 of 6.758 euro per year. 

The  costing  of  a  disclosure  regime  on  bonds  should  be  largely  based  on  the  cost 
evaluation carried out for shares above: the number of reporting entities and the split 
between  small  and  complex  cross  borders  entities  should  be  the  same,  as  the  same 
firms are active in bonds and in shares. 

Along  these  lines,  the  articulation  of  the  costs  of  the  reporting  of  bonds  positions 
should  very  similar.  If  the  banks  set  up  IT  systems  for  reporting  on  shares,  these 
systems  are  likely  to  allow  reporting  of  positions  on  bonds  to  a  large  extent.  They 
may need some adjustments at the margin in order to either increase the capacity of 
systems to also take into consideration reporting on bonds (or to connect to the bond 
positions management systems that may differ slightly from those for shares). In any 
case,  the  one  off  initial  costs  should  be  expected  to  be  marginal  compared  to  the 
initial costs for equities. Conservatively, we can estimate these costs at 25% of the 
initial  costs  for  shares,  with  the  same  variation  between  complex  and  non  complex 
organisations  as  we  have  estimated  for  shares.  One-off  compliance  costs  for  the 
sovereign  bond  disclosure  requirement  could  therefore  be  estimated  to  be  of  the 
order of 34.2 million euro. 

The ongoing costs for bonds should be calculated applying the same ratio of 10% of 
initial costs, leading to an estimated ongoing cost of the order of 3.4 million euro. 

However,  it  is  much  more  difficult  to  assess  the  frequency  of  disclosures  on 
sovereign  bonds  by  financial  institutions,  particularly  as  the  disclosure  threshold  is 
not yet known. Nevertheless, the frequency of disclosure is likely to be lower for two 
main reasons. The first is that there will be only one disclosure threshold for bonds, 

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while there are two different thresholds for shares. The second is that bonds are far 
less frequently traded than shares142,  so short positions on  bonds are  therefore very 
likely  to  vary  far  less  than  those  for  equities.  The  order  of  magnitude  of  the  gap 
between the two could be further estimated by examining the difference between the 
average  frequency  of  bond  trading  compared  to  the  average  frequency  of  share 
trading.  Conservatively,  it  appears  reasonable  to  take  75  %  of  the  number  of 
disclosures  for  shares,  since  the  liquidity  of  sovereign  bonds  is  higher  than  that  of 
corporate bonds, but still less than that of shares. On this basis, we could estimate the 
ongoing  compliance  costs  for  sovereign  bond  disclosures  to  be  of  the  order  of  1.6 
million  euro  per  year.  This  gives  an  estimate  of  the  ongoing  EU-wide  compliance 
cost for disclosure of sovereign bonds of the order of 5 million euro per year. 

7. 

MONITORING AND EVALUATION 

The  Commission  is  the  guardian  of  the  Treaty  and  therefore  will  monitor  how 
Member  States  are  applying  the  changes  proposed  in  the  legislative  initiative  on 
short selling. When necessary, the Commission will pursue the procedure set out in 
Article  226  of  the  Treaty  in  case  any  Member  State  fails  to  respect  its  duties 
concerning the implementation and application of Community Law.  

The  evaluation  of  the  consequences  of  the  application  of  the  legislative  measure 
could take place two years after the entry into force of the legislative measure, in the 
context  of  a report to the Council and the Parliament on the appropriateness of the 
reporting and public disclosure thresholds, which has been recommended by CESR.  

The main indicators and sources of information that could be used in the evaluation 
are as follows: 

•  Data on short positions gathered by national regulators and reported to ESMA on 

a quarterly basis; 

•  Data  on  liquidity  and  spreads  in  the  markets  affected  by  the  short  selling 

initiative; and 

•  A  report  (which  could  be  undertaken  by  ESMA)  on  the  experience  gained  by 
regulators in enforcing the short selling initiative and how cooperation has worked 
in practice. 

142 

According to the analysis of corporate bond market activity in 2008 in a response by the Association for 
Financial  Markets  in  Europe  to  a  consultation  by  CESR  on  the  Directive  on  Markets  in  Financial 
Instruments  dated  4  June  2010:  the  average  percentage  turnover  of  the  most  liquid  corporate  bonds 
compared to issuance size was 121%, compared to an average of 257% for the total European equity 
market in 2008 (based on data by the Federation of European Stock Exchanges).  

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8. 

ANNEX 1 – GLOSSARY OF TERMS 

Short Sales143 

What is a short sale? A short sale is generally the sale of a security you do not own 
(or that you will borrow for delivery). Short sellers believe the price of the security 
will  fall,  or  are  seeking  to  hedge  against  potential  price  volatility  in  securities  that 
they own. If the price of the security drops, short sellers buy the security at the lower 
price  and  make  a  profit.  If  the  price  of  the  security  rises,  short  sellers  will  incur  a 
loss.  Short  selling  is  used  for  many  purposes,  including  to  profit  from  an  expected 
downward  price  movement,  to  provide  liquidity  in  response  to  unanticipated  buyer 
demand,  or  to  hedge  the  risk  of  a  long  position  in  the  same  security  or  a  related 
security. 

Example  of  a  short  sale:  For  example,  an  investor  believes  that  there  will  be  a 
decline in the stock price of Company A. Company A is trading at €60 a share, so the 
investor  borrows  shares  of  Company  A  stock  at  €60  a  share  and  immediately  sells 
them in a short sale. Later, Company A's stock price declines to €40 a share, and the 
investor buys shares back on the open market to replace the borrowed shares. Since 
the  price  is  lower,  the  investor  profits  on  the  difference  --  in  this  case  €20  a  share 
(minus transaction costs such as commissions and fees). However, if the price goes 
up  from  the  original  price,  the  investor  loses  money.  Unlike  a  traditional  long 
position — when risk is limited to the amount invested — shorting a stock leaves an 
investor  open  to  the  possibility  of  unlimited  losses,  since  a  stock  can  theoretically 
keep rising indefinitely. 

How does short selling work? Typically, when a person sells short, their brokerage 
firm will loan them the securities. The securities they borrow come from either the 
firm's own inventory, the margin account of other brokerage firm clients, or another 
lender.  The  person  is  then  able  to  sell  these  borrowed  securities  knowing  that  they 
will  have  to  replace  them  at  an  arranged  later  date.  If  the  securities  which  are 
borrowed  pay  a  dividend,  the  person  must generally pay the dividend to the  owner 
from which the securities were borrowed. 

Large  institutional  investors  and  hedge  funds  will  typically  have  standing 
arrangements  in  place  with  specialist  brokers  and  investment  firms  who  offer  an 
established and arranged facility to borrow securities. These are referred to as Prime 
Brokers and for a fee will manage the lending and administration of the securities as 
well  as  other  services,  e.g.  cash  management.  Other  market  participants  such  as 
settlement  systems  also  offer  facilities  that  enable  investors  to  ensure  that  the 
securities are covered and will be available when settlement is due.  

Uncovered  or  "Naked"  Short  Sales:  In  an  uncovered  short  sale,  the  seller  does  not 
borrow or arrange to borrow the securities prior to executing the trade. If the seller is 
then unable to source the securities before the physical settlement date they will be 
unable to deliver to the buyer (known as a "failure to deliver" or "fail").  

143 

Explanations  are  adapted  inter  alia  from  Key  points  about  Regulation  SHO,  Division  of  Market 
Regulation, Securities and Exchange Commission, 11 April 2005. 
http://www.sec.gov/spotlight/keyregshoissues.htm  

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Failures to deliver can result irrespective of if the seller physically has the securities 
or not and there may be some legitimate reasons for a fail. For example, human or 
mechanical  errors  or  processing  delays  can  result  from  transferring  securities  in 
physical certificate rather than book-entry form, which may happen even if the seller 
physically holds the security. Further, a fail may also result from an uncovered short 
sale when a market maker, in response to a customer order, sells a very thinly traded 
and  illiquid  security.  If  the  market  maker  subsequently  encounters  difficulty  in 
obtaining the security they may be unable to settle. 

1. 

Credit Default Swaps 

A  Credit  Default  Swap  (CDS)  is  a  derivative  which  is  sometimes  regarded  as  a 
form of insurance against the risk of credit default of a corporate or government (or 
sovereign) bond. In return for an annual premium, the buyer of a CDS is protected 
against the risk of default of the reference entity (stated in the contract) by the seller. 
If  the  reference  entity  defaults,  the  protection  seller  compensates  the  buyer  for  the 
cost of default.  

In  addition  to  short  selling  on  cash  markets,  a  net  short  position  can  also  be 
achieved  by  the  use  of  derivatives,  including  Credit  Default  Swaps  (CDS).  For 
example, if an investor buys a CDS without being exposed to the credit risk of the 
underlying  bond  issuer  (a  so-called  "naked  CDS"),  he  is  expecting,  and  potentially 
gaining  from,  rising  credit  risk.  This  is  equivalent  to  short  selling  the  underlying 
bond.  

2. 

Other Terms 

A  Central  Counterparty  (CCP)  is  an  entity  that  acts  as  an  intermediary  between 
trading counterparties and absorbs some of the settlement risk. In practice, the seller 
will sell the security to the central counterparty, which will simultaneously sell it on 
to  the  buyer  (and  vice  versa).  If  one  of  the  trading  parties  defaults,  the  central 
counterparty absorbs the loss. 

A  Derivative  is  a  security  whose  price  is  dependent  upon,  or  derived  from  one  or 
more underlying assets. Examples of derivatives include Options, Futures, CDS, and 
Contracts  for  Difference.  The  underlying  assets  can  be  diverse,  however  common 
examples include shares, bonds, commodities and interest rates.  

Primary  Market  Operations  are  transactions  performed  by  dealers  to  provide 
liquidity to issuers of new securities such as sovereign debt and for the purposes of 
stabilisation  schemes  (i.e.  share  issues  intended  to  stabilise  a  share  price). 
Stabilisation schemes are defined under the Market Abuse Directive. 

A Market Maker is a firm that will buy and sell a particular security on a regular 
and continuous basis by posting or executing orders at a publicly quoted price. They 
ensure  that  an  investor  can  always  trade  the  particular  security  and  in  doing  so 
enhance liquidity in that security. 

Prime Brokers, or firms offering Prime Brokerage services, are firms which offer 
specialist  bespoke  services  to,  generally,  large  institutions  and  hedge  funds.  Prime 
including  securities  borrowing  and 
brokerage  covers  a  range  of  services, 

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administration,  and  cash  management.  Many large  investment  banks  provide  Prime 
Brokerage services. 

A  Multilateral  Trading  Facility  (MTF)  is  an  electronic  system  which  facilitates  the 
exchange  of  securities  between  counterparties.  The  securities  may 
include 
derivatives and instruments which do not have a main market, as well as traditional 
securities. 

A  Trading  Venue  is  an  official  venue  where  securities  are  exchanged;  it  includes 
MTFs and regulated markets (e.g. typical stock exchanges). 

A  Long  Position  refers  to  the  buying  of  a  security  with  an  expectation  that  the 
security will rise in value. 

A  Short  Position  refers  to  the  selling  of  a  security  with  an  expectation  that  the 
security will fall in value. 

A Net Position is where a short position has been subtracted from a long position. If 
the  short  position  is  greater  than  the  long  position  the  result  will  be  a  Net  Short 
Position; if the long position is greater than the short position the result will be a Net 
Long Position.  

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9. 

ANNEX 2 – SUMMARY OF PUBLIC CONSULTATION ON SHORT SELLING  

DG MARKT services held a public consultation between 14 June and 10 July 2010. 
Responses  to  the  public  consultation  were  received  from  finance  ministries  and 
regulators,  investors,  intermediaries,  exchanges  and  clearers,  issuers  and  individual 
citizens (see list in section 9.2 below). 

9.1. 

Summary of the responses 

Some 123 contributions were received, of which 112 were authorised for publication, 
including  2  from  issuers,  55  from  investors  (funds,  banks,  associations,  investment 
funds, savings banks etc), 14 from exchanges, 19 from Member States and Financial 
Agencies (securities regulators, finance ministries and relevant bodies), 5 from non-
financial  institutions  and  17  from  others  (e.g.  chambers  of  commerce,  citizens, 
academics).  

Contributions received from stakeholders varied in detail; most elaborated comments 
were provided by investor groups (funds), exchanges and bodies representing issuers.  

There was a fair degree of consistency in the responses. 

The following general remarks were repeatedly raised with respect to the text: 

–  Most  responses  (especially  from  market  participants  but  also  from  some  public 
authorities)  expressed  strongly  and  consistently  the  view  that  the  consultation 
paper  refers  to  risks  of  short  selling  when  there  is  little  evidence  of  risks.  Most 
responses asked for further evidence to be provided of those risks; however, some 
public  authorities  agreed  with  the  consultation  document's  description  of  the 
potential  risks  of  short  selling.  Many  responses  referred  to  the  benefits  of  short 
selling to market efficiency and quality and some responses included further data 
supporting the positive benefits.  

–  At  the  same  time,  there  was  general  support  for  the  Commission's  aims  of 
introducing  a  harmonised  regime  dealing  with  short  selling  issues  to  avoid 
problems of unilateral approaches to these issues that have recently been seen.  

–  On  scope  the  majority  of  responses  argued  that  the  rules  should  be  limited  to 
shares  and  (to  a  lesser  extent)  sovereign  debt.  There  was  opposition  especially 
from  bond  issuer  bodies  to  an  extension  to  corporate  bonds.  There  were  also 
concerns by corporates about the lack of clarity and unintended consequences of 
extending measures designed for shares to other asset classes. 

–  On transparency many responses (primarily from market participants) argued for 
aggregated  disclosure  to  the  market  of  net  short  positions  in  shares  (instead  of 
individual  disclosure).  On  a  disclosure  regime  for  sovereign  bonds  most 
respondents argued that this should only be disclosed to the regulator.  

–  Regarding  naked  short  selling 

introducing 
requirements  related  to  settlement  discipline  but  a  majority  were  against  any 
restrictions on naked short selling. Some public authorities favoured requirements 

there  was  some  support  for 

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at  the  point  of  trading,  either  on  their  own  or  in  combination  with  rules  on 
settlement discipline. 

–  There  were  mixed  responses  about  emergency  powers  although  most  responses 
seem  to  accept  the  need  for  such  powers  in  an  emergency  situation.  But  many 
argued  that  there  needs  to  be  more  stringent  definition  of  the  powers  and  when 
they can be used. Also some responses argued that ESMA should have a stronger 
coordination role. 

On  exemptions  for  market  makers  there  was  widespread  support  for  an  exemption, 
although there was some limited opposition.  

1. 

SCOPE OF THE PROPOSAL AND SUBSTANTIVE REQUIREMENTS  

1.1.  Scope 

1) Which instruments give rise to risks of short selling and what is the evidence of 
those risks? 

The vast majority stated that there is little evidence of risks. No new data to support 
any  risks  was  submitted,  although  some  public  authorities  agreed  with  the 
description  of  the  potential  risks  in  the  consultation  document.  Many  responses 
referred to evidence of benefits of short selling. 

2) What should be the scope of the requirements? 

The  vast  majority  of  responses  argued  that  proposals  should  only  apply  to  equities 
and  associated  derivatives.  They  felt  that  this  is  the  only  area  where  there  is  any 
evidence of risks. 

A few supported limited measures for sovereign bonds/sovereign CDS. 

There  was  opposition  (especially  from  financial  bond  issuer  bodies)  to  applying 
requirements to corporate bonds as any measures could not be justified and would be 
detrimental to corporate bond issuers. 

There  were  also  opposition  from  corporates  who  use  derivatives  about  applying 
requirements  that  are  designed  for  equities  to  other  assets  classes  such  as  interest 
rates  and  foreign  exchange.  These  respondents  argued  that  such  an  approach  was 
conceptually flawed and would create difficulties for many businesses that use these 
derivatives.  They  argued  it  was  difficult  to  understand  what  the  short  selling 
requirements meant in the context of such instruments or how they would apply. 

3) In what circumstances should measures apply outside the European Union? 

There was broad support for applying some requirements to persons outside the EU, 
but many noted the difficulty of enforcing such a regime. 

1.2.  Transparency  

1) What should be the scope of transparency requirements? 

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The policy option outlined in the consultation document is largely based on the two 
tier  model  for  EU  shares  recommended  by  CESR  in  its  report  in  March  2010.  The 
CESR model provides that at a lower threshold notification of a short position should 
be  made  only  to  the  regulator  and  at  a  higher  threshold  short  positions  should  be 
disclosed to the market. Notification to regulators will enable them to monitor and if 
necessary  investigate  short  selling  that  may  pose  systemic  risks  or  be  abusive. 
Publication  of  information  to  the  market  will  provide  useful  information  to  other 
market  users.  The  consultation  document  included  also  a  specific  regime  for 
notification  to  regulators  only  of  significant  net  short  positions  in  EU  sovereign 
bonds.  Disclosure  to  regulators  of  significant  net  short  positions  relating  to  EU 
sovereign bonds could provide important information to assist regulators to monitor 
whether such positions are creating disorderly markets or systemic risks or are being 
used for abusive purposes. There was support for applying transparency requirements 
in relation to shares. There was some support for applying transparency requirements 
to  sovereign  bonds  (but  not  for  public  disclosure  of  short  positions  in  sovereign 
bonds). 

2) Transparency for notification of short positions in EU shares 

There  was  support  for  these  transparency  measures  although  many  responses  from 
market participants argued for aggregated anonymous disclosure to the market rather 
than disclosure  of  individual positions. These respondents  argued that disclosure to 
the market exposed them to various risks. However, public authorities did not share 
this assessment of the risks of public disclosure of short positions in shares. 

3)  Notification  to  regulators  of  net  short  positions  in  EU  sovereign  debt  (including 
through the use of CDS) 

There  was  limited  support  for  this  measure  although  it  was  noted  that  public 
disclosure of individual positions would be extremely detrimental to sovereign debt 
markets.  

The  majority  of  responses  argued  that  there  should  be  an  exemption  for  primary 
market operations and market makers, although a few argued against exemptions as 
this only involves private disclosure to regulators. 

1.3.  Uncovered short sales  

1) What are the risks of naked short selling and the evidence of those risks? 

Most  responses  thought  there  was  limited  or  no  evidence  of  such  risks,  but 
commented  that  the  primary  risks  are  settlement  failure  and  market  manipulation. 
Some  public  authorities  argued  strongly  that  there  were  risks  of  price  volatility 
associated with naked short selling which could in extreme situations pose a risk to 
financial stability, and that these should be addressed. 

2)  Is  there  evidence  of  risks  of  uncovered  short  selling  for  instruments  other  than 
shares? 

No submission provided evidence of risks, but some public authorities saw the same 
risk for short selling of bonds as for shares. 

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3) Should there be a ban on entering into naked CDS relating to sovereign issuers? 

There was little response to this question. Most of those that did respond pointed out 
there  was  no  evidence  of  a  problem,  although  some  public  authorities  saw  risks  of 
disorderly markets and market manipulation, especially in distressed markets. There 
were comments about the difficulty of defining this concept to take into account the 
various hedging purposes CDS are used for. 

4) Restrictions on uncovered short selling. 

Most responses argued against any restriction on naked short selling due to lack of 
evidence  of  problems,  although  the  issuers  association  and  some  public  authorities 
supported requirements for settlement discipline and/or requirements at the point of 
trading. Many respondents, especially market participants, argued that if a locate rule 
were to be introduced it should include the variety of arrangements that are currently 
used for covered short selling (i.e. not require an agreement to borrow in every case). 

5) Should there be requirements for buy in procedures? 

There was general support for including buy in procedures as this was considered the 
most appropriate means of dealing with settlement risk. 

6) Should there be requirements for marking of orders? 

Most  responses  argued  that  such  a  regime  would  be  excessive  and  costly  without 
adding much benefit, especially as a separate and more comprehensive transparency 
regime was being proposed by the Commission. One public authority responded that 
marking of orders was necessary as a complement to the transparency regime and to 
ensure the enforcement of the short selling regime. 

1.4.  Exemptions  

1) Should there be an exemption for market makers? 

On  exemptions  for  market  makers  there  was  widespread  support  for  an  exemption, 
although there was some limited opposition to any form of exemption. 

2) Should there be an exemption for shares where the principal market is outside the 
EU? 

This  question  was  widely  misinterpreted,  as  most  respondents  assumed  this  was  a 
reference to market makers outside the EU.  

3) Other issues relating to market efficiency? 

There  was  much  comment  about  the  potential  adverse  effect  on  market  liquidity  if 
adequate exemptions for market makers and primary dealers were not provided. 

1.5.  Emergency powers for competent authorities  

1) Are the emergency powers appropriate? 

EN 

79 

   EN 

There was general support for the emergency powers, but many responses (especially 
from market participants) argued that there needed to be more stringent definition of 
the  powers  and  when  they  could  be  used.  Some  public  authorities  called  for  more 
flexibility for national authorities in the exercise of emergency powers. 

2) Should emergency situations be further defined? 

Consistent  with  the  need  for  more  stringent  conditions  around  the  use  of  banning 
powers there was support (especially from market participants) for more prescription 
of the circumstances in which powers can be used. 

3) Should emergency bans be restricted in time? 

The majority agreed that there should be a time restriction. Some thought it should be 
shorter  than  the  max  3  month  period  suggested  (i.e.  with  a  3  month  extension  in 
exceptional  situations).  A  limited  number  thought  an  indefinite  ban  should  be 
permitted.  

4) Are there further measures that would ensure greater coordination of measures in 
an emergency? 

There  was  support  from  respondents  (although  views  were  mixed  among  national 
authorities)  for  further  coordination  of  emergency  measures  and  for  greater 
clarification of the role of ESMA.  

5) Should there be a temporary circuit breaker requirement if prices fall by a certain 
amount? 

Most responses did not see the benefit of such a measure, on the grounds that trading 
venues already had circuit breaker rules that applied if there was a significant price 
fall. However, some respondents argued that a circuit breaker should be introduced 
instead of, or in addition to, emergency powers.  

1.6.  Enforcement and definitions  

1) Are there any special enforcement provisions necessary? 

No views were expressed.  

2) Are the proposed definitions adequate? 

It was suggested that a definition of a "person" be introduced as this was relevant to 
funds  when  calculating  a  net  short  position.  It  was  suggested  that  there  be  further 
definition  of  "net  short  position".  There  was  support  for  a  definition  of  Market 
Maker. 

9.2. 

List of contributors to public consultation 

Exchanges and Clearers – Total 14 

BATS Trading Limited 

BME Spanish Exchanges 

EN 

80 

   EN 

Chi-X Europe 

Deutsche Börse AG 

Euroclear 

FESE 

ICE Futures Europe/ICE Clear Europe 

Irish Stock Exchange 

KDPW (The Central Polish Securities Depository and Clearing House)  

London Metal Exchange 

London Stock Exchange 

NASDAQ OMX  

NYSE Euronext 

Stuttgart Stock Exchange 

Investors and Associated Bodies - Total 55 

ACI  

Af2i  

AIMA 

Allianz SE 

Association française des marchés financiers (AMAFI) 

Asociación Española de Banca 

Association of British Insurers 

Association of Private Client Investment Managers and Stockbrokers (APCIMS) 

Assogestioni 

ASSOSIM 

Barclays Capital 

British Bankers Association 

Bloomberg Tradebook Europe Limited 

Bundesverband Alternative Investments  

EN 

81 

   EN 

BVI (Bundesverband Investment und Asset Management e.V.) 

BWF (Bundesverband der Wertpapierfirmen an den deutschen Börsen e.V.) 

Crédit Agricole Cheuvreux. 

Danish Mortgage Banks' Federation and the Association of Danish Mortgage Banks, 
Joint Submission 

Danish Shareholders Association  

Deutsche Bank AG 

EFAMA  

Eumedion 

European Association of Public Banks 

European Banking Federation  

European Savings Banks Group 

Flow Traders B.V. 

Fogain 

French Banking Federation (FBF)  

Futures and Options Association 

German Insurance Association  

Getco Europe 

Hedge Fund Standards Board 

HSBC 

IMC Trading B.V 

IntesaSanpaolo S.p.A.  

Investment Advisors Association 

Investment Management Association 

Investment Quotient 

ISDA, ISLA, AFME Joint Submission 

Italian Banking Association 

Legal & General Investment Management 

EN 

82 

   EN 

Managed Funds Association (MFA)  

MEDEF 

Nordic Bank, Finance and Insurance Unions (NFU) 

Optiver 

REB (Raad van de Effectenbranche) 

Rivoli Fund Management 

Societe Generale  

Spanish Association of Investment and Pension Funds (INVERCO) 

State Street Bank and Trust Company 

Association Française de la Gestion financière (AFG) 

The Luxembourg Bankers Association 

UniCredit Group 

Verband der Auslandsbanken, Association of Foreign Banks in Germany 

Zentraler Kreditausschuss 

Issuers – Total 2 

EuropeanIssuers 

ICMA 

Member States and Financial Agencies – Total 19 

Autorité des Marches Financiers 

Banca d'Italia  

Banque de France 

CONSOB 

Consultative Committee of the Spanish CNMV  

Czech National Bank 

Danish Central Bank  

Danish Ministry of Economic and Business Affairs 

Det Kongelige Finansdepartement (Norwegian Finance Ministry) 

EN 

83 

   EN 

ECB Eurosystem 

Federal Ministry of Finance, Germany 

Finland Ministry of Finance 

IMF 

Latvian Ministry of Finance 

Ministry for National Economy Hungary  

Ministry of Economy and Finance, Treasury Department, Italy 

Ministère Français de l’Economie, de l’Industrie et de l’emploi 

Swedish Financial Authorities Joint Response 

UK Financial Authorities Joint Response 

Non Financial Institutions – Total 5 

Daimler AG 

Oesterreichs Energie 

Rolls Royce 

Volkswagen Group 

Man SE 

Other – Total 17 

Austrian Federal Economic Chamber 

Bundesarbeitskammer Österreich  

BUSINESSEUROPE 

CFA Society of France 

CFA Society of the UK 

Confederation of Swedish Enterprise  

Deutsches Aktieninstitut 

Deutscher Industrie- und Handelskammertag 

European Trade Union Confederation 

Federation of German Business (BDI)  

EN 

84 

   EN 

IE Business School 

IG BAU  

Interest Capturing Systems, LLC 

International Centre For Financial Regulation 

John Chapman 

Stellungnahme des Deutschen Gewerkschaftsbundes(DGB) 

World Economy, Ecology & Development 

EN 

85 

   EN 

10. 

ANNEX 3: OVERVIEW OF MEASURES IN FORCE IN EU 27 ON SHORT SELLING/CDS 

Disclosure of short 
positions 

Ban on naked short 
selling 

Temporary ban on 
short selling 

Restrictions on 
CDS 

Other – flagging, 
uptick rule  

Austria 

Yes – 0.25% net short 
position 

Yes, temporary ban 
for protected 
financial institutions 

Belgium 

Bulgaria 

Cyprus 

Czech Republic 

Denmark 

Estonia 

Finland 

France 

Germany 

Yes – 0.25% net short 
position 

Yes – for protected 
financial institutions 

Yes, recommendation 
to reg. mkts 

No 

No 

No 

No 

No 

No 

No 

No 

No 

No 

No 

Yes – 0.25% net short 
position for protected 
financial inst. 

Yes for protected 
financial institutions 

Yes – for selected 
financials, 0.2% net 
short positions to reg. 
and 0.5% to public  

Yes for German fin. 
inst., EU sovereign 
bonds 

No 

No 

No 

No 

No 

Yes for protected 
financial 
institutions 

No 

No 

No 

No 

Greece 

No 

Yes temporary ban 
for all shares on EL 
stock exchange 

Yes for all shares 
but rescinded 01 
September 2010 

Hungary 

Ireland 

Italy 

Latvia 

Lithuania 

Luxembourg 

Malta 

Yes – 0.01% gross 
short position 

Yes – 0.25% net short 
position 

No 

No 

No 

No 

No 

The Netherlands 

Yes – 0.25 net short 
position 

No 

No 

No 

No 

Yes – shares should 
be owned or 
borrowed before sale 

Yes in financial 
institutions 

No 

No 

Poland 

No 

No – although 
updated 

EN 

86 

No 

Yes for protected 
financial 
institutions 

Yes but expired 
31.07.09 

No 

No 

No 

No 

Yes but expired 
01.06.09 

Yes but only on 

No 

No 

No 

No 

No 

No 

No 

No 

No 

Yes, ban on naked 
CDS 

No 

No 

No 

No 

No 

No 

No 

No 

No 

No 

No 

No 

No 

No 

No 

No 

No 

No 

No 

No 

Yes – flagging 
and uptick rule 

No 

No 

No 

No 

No 

No 

No 

No 

Yes - flagging 

   EN 

 
requirements 
enhance settlement 

illiquid securities 

Portugal 

Romania 

Slovakia 

Slovenia 

Spain 

Sweden 

UK 

Yes – 0.2% net short 
position to regulator, 
0.5% to public 

No 

No 

No 

Yes – 0.2% net short 
position to regulator, 
0.5% to public 

No 

Yes – 0.25% net short 
position 

Yes 

No 

No 

No 

Yes 

No 

No 

No 

No 

No 

No 

No 

No 

Yes for protected 
fin. inst. but lifted 

No 

No 

No 

No 

No 

No 

No 

No 

No 

No 

No 

No 

No 

No 

Sources: Measures adopted by CESR Members on short selling, CESR 08/742, 22.09.08, updated: 01. 09.10 and 
Clifford Chance, Short selling rules: the global picture, Client Briefing June 2009. 

Note: The above table provides only a high level overview of the most recent available measures and specific details 
should be taken from each Member State's own regulation. 

EN 

87 

   EN 

11. 

ANNEX 4 – SUMMARY OF DISCUSSIONS BETWEEN DG MARKT AND CESR-POL ON 
SHORT SELLING, PARIS, 14 APRIL 2010  

On  14  April,  officials  from  unit  G3  of  DG  Internal  Market  and  Services  of  the 
European  Commission  met  experts  on  short  selling  from  national  regulators  at  the 
premises of CESR in Paris for an exchange of views on short selling. The discussion 
was  structured  according  to  a  discussion  paper  circulated  in  advance  by  the 
Commission  services.  This  note  summarises  the  key  issues  discussed  and  positions 
taken by national regulators on each of the main topics discussed. The positions of 
individual regulators are anonymous at their request. 

1. Scope of the legislation 

The  chairman  of  CESR-Pol  summarised  the  views  of  regulators  as  follows:  no 
Member  State  has  measures  in  place  for  short  selling  of  bonds;  transparency  and 
reporting measures are needed under MiFID for transactions in bonds and derivatives 
(including  CDS);  emergency  powers  for  regulators  on  short  selling  should  cover 
bonds  and  derivatives  as  well  as  shares;  shares  are  not  the  same  as  bonds  or 
derivatives – bond markets are more global and CDS markets more concentrated. 

One regulator said there is some short selling of bonds on their market, but as they 
don't  have  flagging  of  transactions  they  cannot  quantify  it;  there  is  no  evidence  of 
manipulation  or  wider  risks  arising  from  this  which  would  justify  a  regulatory 
response,  and  they  would  need  evidence  of  harm  to  bond  market  to  justify 
introducing  a  net  short  position  disclosure  regime  for  bonds.  They  could  envisage 
mandatory  reporting  for  CDS  transactions  to  trade  repositories  to  enable  proper 
monitoring of possible risks. 

Another regulator believes there is evidence of market abuse on bond markets, they 
have  had some investigations on this, but they lack the tools to know where, when 
and how it occurs. Should we wait for a crisis to occur or anticipate this?  

A regulator said there was only anecdotal evidence of problems on bond markets due 
to the limited tools they have. 

One regulator felt disclosure of short positions in bonds would have an adverse effect 
on liquidity if it was disclosed to the markets. 

One  regulator  argued  there  was  a  risk  of  settlement  failure  for  bonds  due  to  short 
selling; another responded that such risks would only arise from naked short selling 
of bonds and this was not an argument for a disclosure regime; another regulator said 
that settlement failures were not necessarily linked to naked short selling of bonds. 

No other regulators had evidence of short selling in bond markets. 

2. Naked short selling 

CESR-Pol chairman said  that  regulators positions were as follows: some regulators 
wanted  a  total  ban;  some  wanted  a  strong  locate  rule;  and  others  wanted  a  softer 
locate rule like the US. 

EN 

88 

   EN 

He summarised the position as follows: naked short selling poses a risk of settlement 
failure,  this  can  be  dealt  with  by  buy  in  rules  and  by  sanctions  for  late  settlement 
imposed by exchanges and clearing houses. If rules on this are not harmonised at EU 
level there is a risk of regulatory arbitrage. 

One regulator argued that settlement risk does exist for short selling of shares, but in 
the their experience the evidence is that the vast majority of trades settle by the due 
date,  and  where  they  don't,  this  is  less  due  to  short  selling  but  rather  due  to 
administrative  problems.  This  regulator  does  not  see  a  real  threat;  they  have  no 
empirical  study  on  bonds  but  suspect  the  same  is  true  as  for  shares.  This  regulator 
does  not  favour  an  EU  regime  for  naked  short  selling,  if  pressed  could  envisage  a 
soft locate rule. Requiring day traders to arrange to borrow shares would be totally 
disproportionate. 

Another regulator said they have seen settlement problems due to naked short selling, 
although  this  is  not  the  primary  cause,  and  could  provide  evidence  to  the 
Commission. A locate rule should be stronger than the US rule which is too loosely 
worded.  An  EU  provision  should  require  action  to  borrow  shares  before  the  short 
sale. 

Another regulator favours a locate rule and short sales should be flagged.  

One  regulator  felt  naked  short  selling  might  increase  herding  behaviour  and 
destabilise the market, but there is not a big impact on settlement, so they were not 
sure a locate rule would be efficient – the power to ban in an emergency would be 
better. 

Another  regulator  favours  an  obtain  rule  or  failing  that  a  strong  locate  rule;  naked 
short selling causes stock inflation which could be contained by a strong locate rule. 

One  regulator  supported  a  US  style  locate  rule,  felt  it  was  not  necessary  to  forbid 
intra day naked short selling. 

Another regulator favours enhancing settlement discipline and could think about an 
uptick rule. 

Two other regulators favour a US-style locate rule. 

Regulators from ten countries all said they had no experience of naked short selling 
on  their  markets  or  saw  no  evidence  of  risks.  One  Member  State  had  no  strong 
feelings but felt a locate rule would be better than a ban. 

One regulator said they have seen some problems before share issues, and they have 
a US-style locate rule. 

One  regulator  has  less  than  1%  of  settlement  failure  as  they  have  an  obligation  to 
settle on time (two other regulators said they have the same).  

One  regulator  argued  occasional  problems  with  naked  short  selling  do  not  justify 
action; they have imposed penalties in one case of short selling without the intention 
to settle and have exchange rule for settlement. Most short selling in this regulator's 
experience  is  intra-day  with  participants  flat  at  the  end  of  the  day,  so  there  is  no 

EN 

89 

   EN 

settlement  needed  and  no  justification  for  a  locate  rule  in  these  cases.  If  there  are 
problems this is a matter for settlement rules; any locate rule should be a soft one and 
apply only to positions held at the end of the day. 

One regulator has flagging of short sales and an uptick rule, and naked short selling 
is banned since May 2009.  

One  regulator  felt  that  all  were  agreed  on  a  locate  rule,  but  argued  this  should 
comprise an obligation to borrow, with a contract. 

When asked by the Commission services whether regulators supported an EU level 
rule  obliging  settlement  by  the  due  date  as  an  alternative  to  a  locate  rule  –  one 
regulator  agreed  saying  that  a  study  of  the  economic  literature  by  CEMA  argued 
naked short selling was best dealt with by sanctions for settlement  failure. Another 
disagreed, saying action should be at the trading point since naked short selling has a 
leverage  effect  out  of  proportion  to  the  share  capital  of  the  company  concerned. 
Another  favoured  stronger  settlement  discipline  but  as  an  addition,  not  as  an 
alternative, to a locate rule.  

3. Naked CDS 

One  regulator  said  their  corporate  bond  market  is  small  so  the  CDS  market  is  also 
likely to be small; they have no evidence of risks from naked CDS but there is a lack 
of  transparency;  they  see  no  technical  grounds  for  action,  only  if  it  is  abusive,  but 
this is a political issue. 

One regulator said they have a huge CDS market with many players, but lack data to 
say if there is an effect on the market so difficult to say if there are risks. If there was 
evidence of manipulation of sovereign debt markets, they would favour action, which 
could  be  a  total  ban  on  CDS,  or  certain  holding  periods,  or  banning  naked  CDS 
(although the latter would be very difficult to define). 

One regulator said they have daily reporting of CDS transactions and have seen no 
evidence  of  wrongdoing  which  cannot  be  dealt  with  by  MAD  or  transparency  and 
reporting regimes under MiFID. 

Another  regulator  felt  CDS  could  be  a  vehicle  for  market  abuse  and  is  currently 
investigating  a  suspected  case  involving  corporate  CDS  just  before  a  market 
operation. CDS should therefore be included in the MAD; as there is little knowledge 
of  CDS  they  favour  a  more  transparent  regime  in  the  future  derivatives  legislation 
and  they  could  envisage  flagging  of  net  short  CDS  positions.  Banning  naked  CDS 
would not be useful. 

Another regulator agreed there was no case to ban naked CDS, it would be difficult 
to define and there is no evidence of abuse or wider risks. CDS could be a vehicle for 
market abuse as could any financial instrument. This regulator opposes flagging as it 
would be very expensive for participants and difficult to operate, but they support the 
transparency and clearing initiatives foreseen by the Commission. 

Thirteen  regulators  said  they  had  no  market  for  CDS  or  no  evidence  of  risks  but 
would support the power to ban CDS temporarily in an emergency. 

EN 

90 

   EN 

One  regulator  said  there  have  been  allegations  in  the  media  of  manipulation  of 
certain sovereign bonds using CDS which they are investigating. Transparency and 
reporting under MiFID is needed and if those requirements are not met there should 
be a ban; the alternative would be to impose margin and capital requirements. 

The  Commission  services  summed  up  that  all  Member  States  supported  increased 
transparency for CDS through transparency and reporting requirements under MiFID 
and more centralised clearing, and some would favour a flagging requirement. 

4. Emergency powers 

One  regulator  agreed  emergency  powers  for  national  regulators  to  restrict  or  ban 
short  selling  were  needed.  Declaration  of  an  emergency  should  be  left  to  national 
discretion,  not  an  EU-wide  decision,  and  criteria  should  not  be  defined  rigidly  ex 
ante  as  this  could  prevent  a  regulator  from  acting  quickly.  There  should  be  an 
obligation to notify other regulators, if necessary after the event, but consultation or 
coordination  mechanisms  would  not  work  in  an  emergency;  also  not  all  Member 
States may need to act. The duration of an emergency should be restricted or it would 
risk  becoming  permanent  –  one  regulator  has  a  3  month  period  which  can  be 
renewed once. This regulator was sceptical of the revised uptick rule of the SEC, as 
they felt there was no case for an automatic requirement as market conditions were 
too different. 

Thirteen  regulators  agreed  with  this  position,  with  some  nuances.  One  wanted 
flexible  criteria  for  defining  an  emergency  and  did  not  want  to  go  beyond 
consultation  of  ESMA  members.  Another  was  concerned  that  the  article  10 
procedure in the ESMA regulation would prevent action, and that the duration of an 
emergency could not be defined ex ante. Another agreed, and said that the US circuit 
breaker approach should be studied. 

One regulator said regulators needed similar powers and a long term legal base to act 
in an emergency, and favoured a role for ESMA. 

One  regulator  favours  national  discretion  on  declaration  of  emergency,  but  with 
consultation or notification of ESMA members as a minimum. This regulator doubts 
the  efficiency  of  a  circuit  breaker,  this  should  be  analysed  as  it  may  not  be 
appropriate for our markets. 

Another  regulator  agreed  that  it  was  doubtful  if  a  circuit  breaker  would  work  and 
pointed  out  that  many  trading  venues  in  Member  States  have  mechanisms  in  place 
which have the same purpose as a circuit breaker of slowing the fall in share prices 
(e.g.  volatility  auctions  when  stock  falls  more  than  (5%)).  When  there  is  an 
emergency ESMA must play a role, should have a coordinating role before national 
measures. A distinction should be made between EU and national emergencies. 

One  regulator  agreed  that  Europe  has  other  mechanisms  than  a  circuit  breaker,  a 
quantitative trigger is not appropriate. Member  States should have broad powers in 
an  emergency,  there  should  be  no  inconsistency  with  ESMA  regulation  article  10, 
but we should allow for a differentiated approach by Member States. 

Another regulator agreed stock exchanges already have quantitative triggers to stop 
trading, and a 10% drop happens more frequently in some markets than others. 

EN 

91 

   EN 

One  regulator  argued  a  circuit  breaker  would  need  some  coordination  to  be 
considered, so that trading in other markets would be considered. 

Another regulator favoured a coordinating role for ESMA and suggested an MoU. 

5. Powers of regulators 

One  regulator  called  for  the  power  to  ban;  to  introduce  tighter  disclosure 
requirements; to gather information from market participants; also full investigative 
powers and powers to compel people to comply and impose penalties for breaches; 
powers  to  cooperate  with  other  regulators.  Sanctions  should  be  sufficient  to  punish 
and  deter,  and  these  should  not  be  limited  –  in  this  Member  State  sanctions  are 
unlimited.  Another  regulator  disagreed  saying  sanctions  should  be  limited  for 
constitutional reasons. 

One regulator called for a flagging regime to enable surveillance. Another proposed a 
harmonised reporting system including client IDs. 

One  regulator  called  for  the  power  to  suspend  trading  and  the  license  of 
intermediaries to be defined in the regulation.  

Another  agreed  saying  they  suspend  licenses  of  intermediaries  due  to  failures  to 
deliver.  This  regulator  also  argued  that  saying  sanctions  should  have  a  deterrent 
effect  would  not  be  enough  to  ensure  convergence.  We  should  not  fix  a  maximum 
sanction, but a minimum. The publication of measures would also be important for 
enforcement. 

One regulator argued that the EU regime should harmonise these powers. 

Another  called  for  the  power  to  investigate,  and  to  sanction  also  actions  in  other 
territories, and said sanctions should be large enough to deter. 

One  regulator  said  there  should  be  a  power  to  suspend  trading  in  all  or  some 
instruments. 

Another regulator said powers should be broadened so they cover CDS, or they could 
not  take  action  in  an  emergency.  This  regulator  said  it  could  not  ban  naked  short 
selling for a dual listed share if another Member State introduced such a ban. 

One  regulator  said  its  emergency  measures  banned  all  short  selling  in  financial 
instruments anywhere in the world, and this would need the help of other competent 
authorities to enforce.  

The  Commission  services  asked  about  concerns  about  extra-territoriality  –  one 
regulator said this was a concern, but the power was needed in a global market. Two 
other regulators agreed. 

6. Coordination with third countries 

One  regulator  said  this  was  essential  for  any  measures  on  CDS  or  these  could  be 
circumvented.  Agreements  could  be  bilateral  or  through  IOSCO.  If  EU  goes  for  a 
locate rule we should seek international agreement on this approach through IOSCO. 

EN 

92 

   EN 

One  regulator  proposed  a  Memorandum  of  Understanding  (MoU)  with  third 
countries.  Another  pointed  out  that  MoUs  are  helpful  but  don't  supersede  national 
law, so all regulators should have the possibility to cooperate with other countries. 

Two  regulators  proposed  an  ESMA-third  country  master  MoU,  but  stressed  that 
cooperation has to be between national authorities and third countries. 

EN 

93 

   EN 

12. 

ANNEX  5  –  LIST  OF  ORGANISATIONS  REPRESENTED  IN  MEETING  OF  COMMISSION 
SERVICES  WITH  MARKET  PARTICIPANTS  AND  PUBLIC  AUTHORITIES  ON  CREDIT 
DEFAULT SWAPS 

5 March 2010 

Morning Session 

AMF 

BaFin 

Banque de France / ECB 

Bundesbank 

CESR 

French Treasury 

FSA 

Hellenic FSA 

NBB/BNB 

NY FED 

European Commission, officials from DG MARKT and DG ECFIN 

Afternoon session 

AIMA 

Assenagon Fund Management 

Axa Investment 

Barclays Capital 

BlackRock 

Brevan Howard 

Deutsche Bank 

Fitch 

Hypo Real Estate 

EN 

94 

   EN 

 
ICMA 

ING 

Ithuba Capital 

JP Morgan 

Katholieke Universiteit Leuven 

BNB/NBB 

Banque de France / ECB 

European Commission, officials from DG MARKT and DG ECFIN 

EN 

95 

   EN 

13. 

ANNEX 6 – REGULATORY REGIME IN THE UNITED STATES ON SHORT SELLING 

A  number  of  regulatory  developments  which  are  relevant  in  the  context  of  this 
initiative  have  occurred  in  the  United  States  in  recent  months.  Before  coming  to 
those developments, it is necessary to recall the broad regulatory regime which the 
Securities and Exchange Commission (SEC) has applied to short selling over many 
years144.  Following  the  1929  stock  market  crash,  the  SEC  was  established  by  the 
Securities  Exchange  Act  of  1934145  and,  under  the  authority  granted  by  this  Act, 
issued  in  1937  rule  10a-1,  known  as  the  "uptick  rule".  This  limited  short  sales  on 
national  exchanges  to  those  executed  at  an  uptick  (increase  in  price)  over  the  last 
price at which the preceding sale was executed.  

This  uptick  rule  was  adapted  in  several  ways  over  the  years  but  remained  in  force 
until 2007. In 2004, the SEC adopted Regulation SHO146 which introduced a number 
of additional requirements for short selling. In particular, Regulation SHO introduced 
a  'locate'  rule  for  short  sellers,  requiring  them,  before  entering  into  a  short  sale,  to 
borrow  the  share,  have  an  agreement  in  place  to  borrow  the  share  or  have  a 
reasonable belief that the share can be borrowed and delivered by the settlement date. 
Regulation  SHO  also  required  broker-dealers  to  mark  sales  in  all  equity  securities 
"long," "short,"  or "short  exempt" and included a "close-out"  requirement, obliging 
brokers  to  purchase  securities  to  close  out  a  short  position  if  this  position  had 
remained  open  for  at  least  13  days  beyond  the  3  day  settlement  period.  This 
requirement originally only applied to certain securities that had large and persistent 
"fails to deliver", i.e. which failed to be settled within the normal settlement period of 
three days. 

In  July  2007,  the  SEC  abolished  the  uptick  rule,  after  several  years  of  analysis. 
Following a long consultation period in 2009, on 24 February 2010 the SEC adopted 
a new short sale rule, rule 201 of Regulation SHO, known as the "revised uptick" or 
"circuit breaker" rule. This rule restricts short sales of a share whose price has fallen 
by more than 10% compared to its closing price the previous day. The rule restricts 
the  display  or  execution  of  a  short  sale  order  in  such  shares  to  a  price  above  the 
national  best  bid  for  the  rest  of  the  trading  day  and  the  next  trading  day.  The 
exceptions to the rule are limited, as there are no exemptions for bona fide hedging 
or market making147.  

During  the  financial  crisis,  the  SEC  introduced  a  number  of  temporary  emergency 
measures.  On  15  July  2008,  the  SEC  introduced  a  temporary  "pre-borrow" 
requirement  on  short  selling  of  shares  in  19  systemically  important  financial 

144 

145 
146 

147 

This  overview  of  the  current  regulatory  regime  applicable  to  short  selling  in  its  historical  context  is 
taken from the following publication: Short Circuit: New Restrictions on Short Selling in U.S. Equity 
Markets, The D.E. Shaw Group Market Insights, May 2010, Vol. 2 No. 2. 
The Securities Exchange Act of 1934, 6 June 1934, ch. 404, title I, Sec. 1, 48 Stat. 881. 
Regulation  SHO,  Securities  and  Exchange  Commission,  17  CFR  PARTS  240,  241  and  242  [Release 
No. 34-50103; File No. S7-23-03] http://www.sec.gov/rules/final/34-50103.htm#P19_2741  
The  SEC's  New  Short  Sale  Rule:  Implications  and  Ambiguities,  Davis  Polk  Client  Memorandum, 
08.03.2010, p. 4.  

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institutions148. On 18 September the SEC imposed a temporary ban on short sales of 
799 financial stocks149, which grew to 1000 issuers. In September 2008 the SEC also 
tightened  the  "close-out"  requirement  of  Regulation  SHO  so  that  it  applied  to  all 
securities not settled the day after the normal settlement date, and imposed temporary 
reporting  requirements  on  certain  short  sales  and  positions  on  institutional  money 
managers with assets under management of USD 100 million or more.150  

On  1  August  2009  temporary  rule  10a-3T,  which  required  disclosure  to  the 
authorities  of  certain  aggregated  data  on  short  selling  transactions,  expired.  Since 
then,  the  SEC  has  been  working  with  self-regulatory  organisations  to  make  short 
selling  volume  and  transaction  data  available  to  the  public  through  the  latter's  web 
sites.  

Regarding CDS, these fall within the scope of the Wall Street Reform Act enacted by 
President  Obama  on  21  July  2010,  and  the  CFTC  and  SEC  will  be  expected  to 
produce joint rules to implement this. In particular, the Act requires the CFTC and 
SEC  to  adopt  rules  on  real  time  disclosure  to  the  public  of  swap  transactions, 
including  price  and  volume;  clearing  of  all  swaps  that  the  CFTC  or  the  SEC 
determine should be cleared, except for commercial end-users; and all swaps subject 
to clearing should be traded on a securities exchange or similar facility151. 

The Act also includes certain provisions on short selling, notably it requires the SEC 
to adopt rules for public disclosure, at least monthly, of the amount of short sales by 
institutional  investment  managers152.  It  also  obliges  broker-dealers  to  notify  their 
clients that they can opt not to allow their securities to be lent out for short selling, 
explicitly makes manipulative short selling illegal and allows the SEC to adopt rules 
to enforce this provision. The Act also requires the SEC to carry out a cost-benefit 
study within a year on real time reporting of short sale positions and another study 
within two years on the state of play following the enactment of short selling rules.153 

148 

149 

150 
151 

152 
153 

SEC Release 34-58166, Emergency Order Pursuant to Section 12(k)(2) of The Securities Act of 1934 
Taking  Temporary  Action  to  Respond  to  Market  Developments,  July  15,  2008.  Available  at: 
http://www.sec.gov/rules/other/2008/34-58166.pdf. 
SEC,  Emergency  Order  Pursuant  to  Section  12(k)(2)  of  the  Securities  Exchange  Act  of  1934  Taking 
Temporary  Action  to  Respond  to  Market  Developments.  Release  34-58572.  September  17,  2008. 
Available at: http://www.sec.gov/rules/other/2008/34-58572.pdf. 
The D.E. Shaw Group Market Insights, May 2010, p. 6. 
Davis  Polk,  Summary  of  the  Dodd-Frank  Wall  Street  Reform  and  Consumer  Protection  Act,  Enacted 
into Law on July 21 2010, 21 July 2010, pp. 52-63. 
Ibid,, p. 70. 
Ibid, p.68. 

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14. 

ANNEX 7 – BIBLIOGRAPHY OF RECENT ECONOMIC LITERATURE ON SHORT SELLING, 
COMMITTEE ON ECONOMIC AND MARKET ANALYSIS (CEMA), CESR 

Date: 10 June 2010 

Ref: CESR/10-334 

CEMA – Short selling WG 

Recent economic literature on short selling and “naked CDS” 

Academic economic literature on short selling 

Working papers on short selling/ short selling measures 

Naked short selling 

Boulton,  Thomas  J.,  and  Marcus  V.  Braga-Alves,  2009,  Naked  short  selling  and 
market returns, Working paper, Miami University. 

Culp,  Christopher,  and  J.B.  Heaton,  2008,  The  economics  of  naked  short  selling, 
Regulation, Spring. 

Fotak, Veljko, Vikas Raman, and Pradeep K. Yadav, 2009, Naked short selling: The 
emperor’s new clothes?, Working paper, University of Oklahoma. 

Murphy, Austin, Hong Qian, and Yun Ellen Zhu, 2010, “An Empirical Examination 
of  the  Relationship  between  Naked  Shorting  and  Share  Prices  Around  the 
Announcement of a Firm’s Need for External Capital”, Oakland University - School 
of Business Administration 

Stone,  Elizabeth  C.  “Fails  to  Deliver:  The  Price  Impact  of  Naked  Short  Sales”, 
Stanford University. 

Putnins, Talis Janis, 2010, “Naked Short Sales and Fails to Deliver: An Overview of 
Clearing and Settlement Procedures for Stock Trades in the US”, Stockholm School 
of Economics. 

Moffett, Clay M., Robert Brooks, and Jin Q Jeon , 2010, “The Efficacy of Regulation 
SHO  in  Resolving  Naked  Shorts”,  University  of  North  Carolina  Wilmington, 
Cameron School of Business. 

Short-sale bans 2008 

Autore,  Don  M.,  Randall  S.  Billingsley,  and  Tunde  Kovacs,  2009,  Short  sale 
constraints, dispersion of opinion, and market quality: Evidence from the short sale 
ban on U.S. financial stocks, Working paper, Florida State University.  

Boehmer,  Ekkehart,  Charles  M.  Jones,  and  Xiaoyan  Zhang,  2009,  Shackling  short 
sellers: The 2008 shorting ban, Working paper, Texas A&M University. 

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Boulton,  Thomas  J.,  and  Marcus  V.  Braga-Alves,  2009,  The  skinny  on  the  2008 
naked short sale restrictions, Working paper, Miami University.  

Gagnon, Louis, and Jonathan Witmer, 2009, Short changed? The market’s reaction to 
the short sale ban of 2008, Working paper, Queen’s University. 

Gruenewald, Seraina, Alexander F. Wagner, and Rolf H. Weber, 2009, Short selling 
regulation  after  the  financial  crisis  –  First  principles  revisited,  Working  paper, 
University of Zurich. 

Grundy,  Bruce  D.,  Bryan  Lim,  and  Patrick  Verwijmeren,  2009,  Do  option  markets 
undo  restrictions  on  short  sales?  Evidence  from  the  2008  short-sale  ban,  Working 
paper, University of Melbourne. 

Khanna, Naveen, and Richmond D. Mathews, 2009, Bear raids and short sale bans: 
Is government intervention justifiable?, Working paper, Duke University. 

Kolasinksi, Adam, Adam V. Reed, and Jacob R. Thornock, 2009, Prohibitions versus 
constraints:  The  2008  short  sales  regulations,  Working  paper,  University  of 
Washington. 

Lobanova,  O.,  S.S.  Hamid,  and  A.J.  Prakash,  2010,  "The  Impact  of  Short-Sale 
Restrictions on Volatility, Liquidity, and Market Efficiency: The Evidence from the 
Short-Sale  Ban  in  the  U.S."  Department  of  Finance,  College  of  Business,  Florida 
International University. 

Short selling since 2008 

Avgouleas,  Emilios,  2010,  “A  New  Framework  for  the  Global  Regulation  of  Short 
Sales:  Why  Prohibition  is  Inefficient  and  Disclosure  Insufficient”  University  of 
Manchester - School of Law 

Autore, Don M., Thomas J. Boulton, and Marcus V. Braga-Alves, 2010, “Failures to 
Deliver, Short Sale Constraints, and Stock Overvaluation”, Florida State University - 
College of Business. 

Battalio, Robert H., and Paul H. Schultz, 2010, “Regulatory Uncertainty and Market 
Liquidity: The 2008 Short Sale Ban's Impact on Equity Option Markets” University 
of Notre Dame - Department of Finance 

Berber, Allesandro, and Marco Pagano, 2010, Short-Selling bans around the world: 
evidence from the 2007-09 crisis, CSEF working paper. 

Blocher,  Jesse,  Joseph  Engelberg,  and  Adam  V.  Reed,  2009,  The  long  short  wars: 
Evidence of incentive driven short selling by hedge funds, Working paper, UNC at 
Chapel Hill. 

Boehmer,  Ekkehart,  and  Julie  Wu,  2009,  Short  selling  and  the  informational 
efficiency of prices, Working paper, Texas A&M University. 

Bardong,  Florian,  Sohnke  M.  Bartram,  and  Pradeep  K.  Yadav,  2008,  Are  short-
sellers different from ‘regular’ trades?, Working paper, Lancaster University. 

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Boehmer,  Ekkehart,  Bilal  Erturk,  and  Sorin  Sorescu,  2008,  Why  do  short  interest 
levels predict stock returns?, working paper, Texas A&M University. 

Boehmer, Ekkehart, Charles M. Jones, and Xiaoyan Zhang, 2008, Unshackling short 
sellers: The repeal of the uptick rule, Working paper, Texas A&M University. 

Bris, Arturo, 2008, Short Selling Activity in Financial Stocks and the SEC July 15th 
Emergency Order, Working paper, IMD, European Corporate Governance Institute, 
and Yale International Center for Finance.  

Comerton-Forde,  Carole, and Tālis J. Putniņš, 2009: Are short sellers manipulating 
the market?, University of Sydney 

Edwards, A. and K. Hanley, 2008, Short Selling in Initial Public Offerings, Working 
Paper. 

Engelbert, Joseph E., Adam V. Reed, and Matthew C. Ringgenberg, 2010, How are 
shorts  informed?  Short  sellers,  news,  and  information  processing,  Working  paper, 
University of North Carolina. 

Fox,  Merritt  B.,  Lawrence  Glosten,  and  Paul  Tetlock,  2009,  Short  Selling  and  the 
News: A Preliminary Report on an Empirical Study, Working Paper. 

Hansson,  Fredrik  and  Erik  Rüdow  Fors,  2009,  Get  Shorty?  Market  Impact  of  the 
2008-09 U.K. Short Selling Ban, University of Gothenburg. 

Harris,  Lawrence,  Ethan  Namvar,  and  Blake  Phillips,  2009,  Price  Inflation  and 
Wealth Transfer During the 2008 SEC Short-Sale Ban, Working paper, University of 
Southern California. 

Henry,  T.R.,  D.J.  Kisgen,  and  J.  Wu,  2010,  "Do  Equity  Short  Sellers  Anticipate 
Bond Rating Downgrades?", University of Georgia.  

Khan, Mozaffar, and Hai Lu, 2009, Do short sellers front-run insider sales?, Working 
paper, MIT. 

Lioui,  Abraham,  2009,  The  undesirable  effects  of  banning  short  sales,  EDHEC 
working paper. 

Lioui,  Abraham,  2010,  "Spillover  Effects  of  Counter-Cyclical  Market  Regulation: 
Evidence from the 2008 Ban on Short Sales"  

Purnanandam, Amiyatosh, and Nejat Seyhun, 2009, Do short sellers trade on private 
information or false information?, Working paper, University of Michigan. 

SEC Office of Economic Analysis Memorandum, January 14, 2009, Analysis of the 
July Emergency Order Requiring a Pre-Borrow on Short Sales,  

Saffi,  Pedro  A.,  and  Kari  Sigurdsson,  2008,  Price  efficiency  and  short  selling, 
Working paper, IESE Business School. 

Wang, Jun, Steven X. Wei, and Bohui Zhang, 2008, Short sale constraints and price 
informativeness, Working paper, Hong Kong Polytechnic University. 

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Westerholm,  P.  Joakim,  and  MD  Mostafa  Ahmed,  2009,  The  Impact  of  Actual 
Market  Wide  Short  Selling  Restrictions  and  Liquidity  Constraints  During  the 
Financial Crisis of 2008, University of Sidney 

Published / accepted papers on short selling/ short selling measures 

Goldstein I. and Guembel A. (2008). Manipulation and the allocation role of prices. 
Review of Economic Studies, vol 75, 133-164. 

Henry, Tyler R., and Jennifer L. Koski, 2009, Short selling around seasoned equity 
offerings, Review of Financial Studies, 3rd round. 

Karpoff,  Jonathan  M.,  and  Xiaoxia  Lou,  2010,  Short  sellers  and  financial 
misconduct, Journal of Finance, forthcoming.  

Edwards, Amy K., and Kathleen Weiss Hanley, 2010, Short selling in initial public 
offering, Journal of Financial Economics, forthcoming. 

Chen,  Crystal  Xiaobei,  and  S.  Ghon  Rhee,  2010,  The  impact  of  short  sales  on  the 
speed of price adjustment: Evidence from the Hong Kong stock market, Journal of 
Banking & Finance 34, 471-483.  

Christophe, Stephen E. , Ferri, Michael G., and Hsieh, Jim, 2010, Informed trading 
before  analyst  downgrades:  evidence  from  short  sellers,  Journal  of  Financial 
Economics 95, 85-106. 

Boehmer, Ekkehart, Brad Jordan, and Zsuzsa Huszar, 2010, The good news in short 
interest, Journal of Financial Economics, in press. 

Regulatory literature on short selling 

FSA, 2009, Short selling, Discussion paper. 

IOSCO, 2009, Regulation of short selling, March. 

SFC  (Securities  and  Futures  Commission),  2009,  How  short-selling  activity  affects 
liquidity of the Hong Kong stock market, April 

Literature on short selling from market participants 

Clifton, Matthew, and Mark Snape, 2008, The effect of short-selling restrictions on 
liquidity:  Evidence  from  the  London  Stock  Exchange,  report  commissioned  by  the 
London Stock Exchange.  

Deutsche  Bank,  2010,  Short  selling  -  Important  business  in  need  of  globally 
consistent rules 

Marsh,  I.,  Niemer,  N.,  2008:  The  Impact  of  Short  Sales  Restrictions,  International 
Securities  Lending  Association,  (ISLA)  the  Alternative  Investment  Management 
Association (AIMA) and London Investment Banking Association (LIBA) 

Oliver Wyman, 2010, Effects of short selling disclosures 

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Literature on “naked CDS” 

Duffie,  Darrell,  2010:  Is  There  a  Case  for  Banning  Short  Speculation  in  Sovereign 
Bond Markets?, Stanford University 

Portes, Richard, 2010: Ban Naked CDS, London Business School and CEPR 

EN 

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15. 

ANNEX 7 – DATA ON SHARES OUTSTANDING ON LOAN AS A PROXY FOR VOLUME OF 
SHORT  SELLING  TRANSACTIONS  IN  THE  EUROPEAN  UNION,  PROVIDED  BY 
DATAEXPLORERS 

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EN 

104 

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EN 

105 

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16. 

ANNEX 8 – ESTIMATE OF COMPLIANCE COSTS  

The Commission services assessed the compliance costs of the preferred options. To assist the 
policy  development  process,  DG  MARKT  issued  a  survey  on  the  expected  impacts  of 
different  policy  options  to  firms  with  significant  short  selling  activities  and  received  50 
responses. We also received 20 Member States/ national competent authorities' responses with 
non-attributable background information on short selling. 

Currently there are eleven Member States with short selling disclosure regimes (see Annex 3).  

The preferred options include requirements for firms to ensure regulators and markets obtain 
data on short positions (including CDS): 

•  Disclosure of short positions to the regulator; 

•  Disclosure of short positions to the public. 

As part of this option, regulators would be expected to provide quarterly reports to ESMA on 
the net short positions notified or disclosed within their jurisdiction. This section provides an 
estimate of the compliance costs (including both one-off and ongoing costs) implied by these 
requirements. 

1. Compliance costs for firms subject to the disclosure requirements 

It is assumed that the compliance costs are best described by the following elements: 

•  One-off  costs  for  the  development  for  training,  setting  up  procedures  and 
establishing  Information  Technology/Information  Systems  (IT/IS).  These  costs 
are assumed to depend on the complexity of the entity subject to the requirement. 

•  Ongoing costs for training, procedures and maintenance of IT/IS systems. These 
costs are assumed to be proportional with the one-off costs, and hence also depend 
on complexity of the entity. 

•  Ongoing costs depending of the number of notifications. This primarily concerns 
the time spent once the systems have flagged the need to perform a notification. 

In order to estimate the one-off costs, firstly the number of reporting firms on short position is 
estimated, and secondly the average cost per firm (according to its complexity) is estimated. 
The firms are grouped into two categories: complex cross-border firms and other firms. The 
complex cross-border firms are characterised as global financial market players operating in 
all EU Member States. Other firms are all small and medium sized firms operational in one or 
few Member States. 

The  ongoing  cost  for  maintenance  of  IT/IS  systems,  the  due-diligence  process,  training  and 
setting up procedures is assumed, on an annual basis, to be a fraction of the one-off-costs in 
that  regard.  The  remaining  ongoing  costs  are  assumed  to  depend  on  the  number  of  actual 
notifications.  The  requirement  for  publication  when  the  0.5%  threshold  is  crossed  is  not 
accounted for separately, since this threshold is also requires a notification to the regulator. 

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1.1 One-off costs IT/IS development, training and compliance procedures 

Based on the responses provided by the survey, an estimated percentage of investment firms, 
credit institutions authorised to provide investment services and their foreign branches subject 
to  these  disclosure  requirements  would  consequently  amount  to  around  12%  (see  table 
below).  This  assumption  is  based  on  the  average  of  percentage  of  entities  notifying  short 
positions in the UK and Spain at the moment. 

Table  1  –  Ratio  of  firms  subject  to  the  disclosure  requirements  and  being  potentially 
exposed to compliance costs 

MS

Number of Reporting 
Entities

Number of investment firm, 
credit institutions authorised to 
provide investment services and 
foreign branches

Ratio of 
reporting 
firms

(1)

(2)

UK
Spain

400
56

(3)=(1)/(2)
0,10
0,13

3.921
434

Average:

0,12

The  total  number  of  investment  firms,  credit  institutions  authorised  to  provide  investment 
services and their foreign branches is 11,999. We estimate that there should be approximately 
1,440 firms (11,999 x 0.12) in the EU subject to the disclosure obligations. We also estimate 
that there may be 10%154 of complex cross-border firms and 90% of other firms. Furthermore, 
we extrapolate from the results of the responses provided from some market participants and 
from  some  regulators  to  make  an  assumption  that  the  average  costs  for  IT/IS  development, 
training  and  compliance  procedures  could  be  estimated  at  approximately  500,000  Euro  for 
complex cross-border firms and 50,000 Euro for other firms155.  

154 

155 

EN 

The  10%  estimate  is  reached  by  considering  the  total  number  of  firms  that  are  significantly  more 
complex in their operations than the rest. This is typically large investment banks and other entities with 
a variety of activities across Member States. 10% amount to 144 entities across the 27 Member States, 
or  approximately  5  per  Member  State.  For  some  Member  States  this  would  be  a  low  figure,  but  in 
average this is probably a slightly high estimate. The resulting estimates should therefore probably be 
considered prudent in terms of not underestimating the full compliance costs. 
An interview with one of the biggest investment banks indicated that their one-off implementation costs 
would  probably  be  €0.5  million.  On  the  other  hand,  the  complexity  of  the  business,  and  hence  the 
number of positions to take into account for calculating the overall exposure, was considered very high 
compared to most other entities. The cost for less complex entities should on average therefore only be 
a  fraction of  that  incurred by  a  large  investment  bank.  It is  likely  that  the difference  in  the  degree of 
complexity could be said to be a factor of 50 or even 100. However, the cost does probably not decrease 
proportionally with less complex structures due to minimum costs incurred with system changes. As a 
result  we  have  found  it  reasonable  to  assume  that  less  complex  entities  will  incur  a  cost  of  10%, 
compared to the most complex companies. Due to the importance of this estimate effort has been made 
to understand the operational aspect of the requirement. 

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Table 2 – Estimation of costs of IT/IS development, training and compliance procedures  

Classification of Reporting 
Entity

Estimated division of 
total number EU 
reporting entities on 
short position (%) 

Estimated number of 
reporting firms on 
short positions

Average IT/IS 
development, training 
and compliance 
procedures (one-off) 
cost/entity

Total IT/IS development, 
training and compliance 
procedures (one-off) 
costs due to the short 
position notification

Complex cross-border

Others

TOTAL

(1)

(2)=(1)*1.440

(3)

(4)=(2)*(3)

10%

90%

100%

144

1.296

1.440

500.000

50.000

550.000

71.994.000

64.794.600

136.788.600

1.2  Estimate  of  on-going  costs  based  on  national  reporting  requirements  for  financial 
institutions only 

Based on the responses provided by the survey, we identify two types of on-going costs: 

1. IT/IS upgrade and maintenance. 

2. Reporting of short positions. 

We estimate the IT/IS upgrade and maintenance costs to be 10% of the initial cost of IT/IS 
development (including training and compliance procedures) for all the EU reporting entities.  

Table 3 – Estimates of IT/IS upgrade and maintenance costs (on a yearly basis)  

Classification of Reporting 
Entity

Total IT/IS development, 
training and compliance 
procedures (one-off) 
costs due to the short 
position notification

IT/IS upgrade & 
maintenance/year/enti
ty (%)

Total EU IT/IS upgrade 
& maintenance 
costs/year

Complex cross-border

Others

TOTAL

(1)

(2)

(3)

71.994.000

64.794.600

136.788.600

10%

10%

7.199.400

6.479.460

13.678.860

Furthermore, an estimate of disclosure frequency is based on the relevant data provided by six 
national competent authorities. Five out of six national competent authorities have in recent 
months  applied  disclosure  rules  providing  for  a  threshold  of  0.25%  of  net  short  positions. 
Under  this  requirement,  the  disclosure  of  short  positions  to  the  relevant  national  competent 
authority was done after the crossing of the threshold. As the regulators have provided data 
for variable periods (see Table 4, disclosure period provided by regulators), we recalculated 
the disclosure numbers on a yearly basis. 

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Table  4  –  Estimates  of  yearly  disclosure  numbers  per  Member  State  (MS)  and  yearly 
average disclosure number for six MS  

MS

UK

Spain

Germany

France

Netherlands

Portugal

Number of Disclosures of Short-Selling

To Regulators

To Public

156

441

102

108

73

24

N/R

N/R

N/R

45

11

Total
(1)

156

441

102

108

73

24

Disclosure Period provided by 
Regulators

Number 
Months
(2)

Recalculated per 
Year
(3)=(1)/(2)*12

12 months

from 24/09/08 to 10/06/10

from 4 March 2010 to 02/06/2010

from 01/09/2008 to 01/06/2010

from 01/06/2009 to 01/06/2010

from 01/01/2010 to 01/06/2010

12

20

3

21

12

5

156

265

408

62

73

58

Furthermore, we apply a grouping methodology to estimate the disclosure numbers of short 
positions  for  all  the  EU  Member  States.  The  countries  are  grouped  into  three  categories 
according  to  the  likely  frequency  of  disclosures  per  year:  high,  medium  and  low.  Based  on 
available  information  (see  table  4)  and  also  based  on  our  extrapolated  number  of  reporting 
firms  subject  to  disclosure  regulation  (see  table  5,  columns  1  and  2),  we  extrapolate  the 
assumed  weight  of  short  positions  to  be  disclosed  and  allocate  the  potential  number  of 
disclosures to each Member State (see table 5, column 5).  

Table  5  –  Assumed  exposure  to  short  positions  and  yearly  average  disclosure  number 
(sorted in ascending order)  

N°

Member State

Number of investment 
firms, credit institutions 
authorised to provide 
investment services and 
foreign branches

Estimated number 
of reporting firms 
on short positions 
(EU)

Number of 
Disclosures of 
Short-Selling

Assumed exposure to 
Short positions (based 
on National Competent 
Authorities responses)

Yearly average 
disclosure 
number

(3) (see table 4) 

(4)

(5)

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27

Latvia
Bulgaria
Estonia
Lithuania
Slovenia
Slovakia
Hungary
Czech Republic
Portugal
Poland
Romania
Malta
Cyprus
Greece
Belgium
Netherlands
Luxembourg
Ireland
Sweden
Finland
Spain
France
Denmark
Italy
Austria
Germany
United Kingdom
TOTAL

(1)
N/A
N/A

N/A

(2)=(1)*0,12
N/A
N/A

N/A

26
26
26
41

57
76
80
85
91
97
116
132

N/A

N/A

199
235
271
382
434
490
671
881
975
2687
3921
11.999

3
3
3
5

7
9
10
10
11
12
14
16

24
28
33
46
52
59
81
106
117
322
471
1.440

58

73

265
62

408
156

Low
Low
Low
Low
Low
Low
Low
Low
Low
Low
Low
Low
Low
Medium
Medium
Medium
Medium
Medium
Medium
Medium
High
High
High
High
High
High
High

58
58
58
58
58
58
58
58
58
58
58
58
58
73
73
73
73
73
73
73
223
223
223
223
223
223
223

We estimate that reporting disclosure information will take 2 hours. The estimate is based on 
information collected from some market participants. 

EN 

109 

   EN 

 
 
As regards the costs (hourly wage) we did not obtain relevant figures about the distribution 
from across the Member States. However, taking into consideration that a large proportion of 
notifications are likely to be made by complex cross-border entities, often with a centralised 
compliance function located in a high-cost country, it appears appropriate to apply an average 
hourly wage of managers from such a Member State. The hourly wage of managers156 in the 
UK is estimated to € 52.81, and is used in the following calculations. 

Table 6 – Calculation of compliance cost of disclosure for Short position requirements for 
shares in financial institutions only  

No Member State

Assumed exposure to 
Short positions (based 
on National Competent 
Authorities responses)

Yearly average 
disclosure 
number on Short 
positions

Total costs 
(based on 
assumed 
exposure) 

(1)

(2)=(1)*52,81*2

1 Austria

2 Belgium

3 Bulgaria

4 Cyprus

5 Czech Republic

6 Denmark

7 Estonia

8 Finland

9 France

10 Germany

11 Greece

12 Hungary

13 Ireland

14 Italy

15 Latvia

16 Lithuania

17 Luxembourg

18 Malta

19 Netherlands

20 Poland

21 Portugal

22 Romania

23 Slovakia

24 Slovenia

25 Spain

26 Sweden

27 United Kingdom

TOTAL

High

Medium

Low

Low

Low

High

Low

Medium

High

High

Medium

Low

Medium

High

Low

Low

Medium

Low

Medium

Low

Low

Low

Low

Low

High

Medium

High

223

73

58

58

58

223

58

73

223

223

73

58

73

223

58

58

73

58

73

58

58

58

58

58

223

73

223

23.553

7.710

6.126

6.126

6.126

23.553

6.126

7.710

23.553

23.553

7.710

6.126

7.710

23.553

6.126

6.126

7.710

6.126

7.710

6.126

6.126

6.126

6.126

6.126

23.553

7.710

23.553

298.482

156 

The hourly wages are based on standardised ESTAT data (the four-yearly Labour cost survey and the 
annual  updates  of  labour  cost  (ALC)  statistics),  reflecting  2006  figures.  They  already  contain  the 
standard 25% overhead costs, as required by the Standard Cost Model . 

EN 

110 

   EN 

 
                                                 
1.3 On-going costs for disclosure of short positions in all EU shares  

Given that under the proposed option all EU shares will be subject to the disclosure regime of 
short  positions  so  the  number  of  disclosures  will  increase.  The  number  of  daily  disclosures 
will vary according to the disclosure regime using the 0.2%, 0.3%, 0.4% and 0.5% threshold 
levels. 

Table 7 – Statistical Findings in the UK157  

Statistical Findings

Threshold

Average no. Disclosures per threshold

Number of Notifications

0,20

1,18

472

0,30

0,78

312

0,40

0,45

180

0,50

0,39
156  

A  survey  in  the  UK  provides  a  basis  for  estimating  the  number  of  disclosures  in  the  case 
where a broader set of shares are part of the regime and where multiple thresholds are used. 
As previously stated the actual number of notifications in the UK on an annual basis was 156 
with  a  single  threshold  for  0.25%.  The  number  of  notifications  at  0.2%  and  0.3%  is 
significantly  higher  most  probably  due  to  the  broader  scope  of  shares.  The  average  of  the 
notifications at these thresholds is 392 [(472 + 312)/2], indicating that the overall number of 
notifications would increase by a factor of 2.5 [(392/156)] due to the broader scope. This is 
reflected in the calculation (see tables 8 and 9). In addition the total number of notifications is 
likely to increase with the higher number of thresholds. The UK survey gives an indication of 
the relative frequency with which the various thresholds are likely to trigger a notification. On 
this basis, the factor with which the number of notifications will increase due to the increase 
to 4 thresholds instead of 1 can be estimated to 2.86 [(472 + 312 + 180 + 156)/392].  

These results have been used for our extrapolation to get an estimate of the yearly disclosures 
all 27 EU regulators might receive (see table 8). 

Table 8 – Estimates for reporting on-going costs per threshold (0.2; 0.3; 0.4; 0.5)  

Short position reporting on-going costs: 27 Member States estimate

Threshold

Reporting Administrative burden 

Total threshold: 0,2

Total threshold: 0,2; 0,3

Total threshold: 0,2; 0,3; 0,4

Total threshold: 0,2; 0,3; 0,4; 0,5

0,20

903.100

903.100

903.100

903.100

903.100

0,30

596.964

0

1.500.064

1.500.064

1.500.064

0,40

344.402

0

0

1.844.466

1.844.466

0,50

298.482

0

0

0

2.142.949

We  estimate  that  the  on-going  compliance  cost  for  disclosure  of  short  positions  will  be 
approximately 2.1 million Euros (see calculation details in table 10). 

1.4 On-going costs for disclosure of short positions by regulators to ESMA  

The  regulators/national  competent  authorities  will  be  required  to  disclose  quarterly  short 
positions  to  ESMA.  We  estimate  that  reporting  disclosure  information  will  take  2  hours.  In 

157 

Short selling disclosure thresholds: findings of FSA survey. Communication to CESR, 8/12/2009. 

EN 

111 

   EN 

 
                                                 
order  to  calculate  the  administrative  cost,  we  use  the  hourly  wages158  of  manager  in  EU 
Member States (see table 9). 

Table 9 – Estimates for reporting to ESMA on-going costs 

Member State Hourly wage of 

managers
(1)

Reporting disclosure 
cost/year
(2)=(1)*2*4

Austria

Belgium

Bulgaria

Cyprus

Czech Republic

Denmark

Estonia

Finland

France

Germany

Greece

Hungary

Ireland

Italy

Latvia

Lithuania

Luxembourg

Malta

Netherlands

Poland

Portugal

Romania

Slovakia

Slovenia

Spain

Sweden

United Kingdom

TOTAL

51,53

50,63

3,3

31,64

11,52

51,99

8,1

44,75

51,14

46,4

26,98

11,66

49,56

61,5

5,86

7,38

56,63

16,67

36,88

13,02

31

9,73

7,83

18,34

37,11

50,8

52,81

412

405

26

253

92

416

65

358

409

371

216

93

396

492

47

59

453

133

295

104

248

78

63

147

297

406

422
6.758  

158 

The hourly wages are based on standardised ESTAT data (the four-yearly Labour cost survey and the 
annual  updates  of  labour  cost  (ALC)  statistics),  reflecting  2006  figures.  They  already  contain  the 
standard 25% overhead costs, as required by the Standard Cost Model. 

EN 

112 

   EN 

                                                 
E
N

1
1
3

E
N

On-going costs for 
disclosure for 
Short position 
requirements for 
shares in financial 
institutions only

On-going costs for disclosure of short positions in all EU shares

No Member State

Assumed 
exposure to Short 
positions (based 
on National 
Competent 
Authorities 
responses)

1 Austria

2 Belgium

3 Bulgaria

4 Cyprus

5 Czech Republic

6 Denmark

7 Estonia

8 Finland

9 France

10 Germany

11 Greece

12 Hungary

13 Ireland

14 Italy

15 Latvia

16 Lithuania

17 Luxembourg

18 Malta

19 Netherlands

20 Poland

21 Portugal

22 Romania

23 Slovakia

24 Slovenia

25 Spain

26 Sweden

27 United Kingdom

TOTAL

High

Medium

Low

Low

Low

High

Low

Medium

High

High

Medium

Low

Medium

High

Low

Low

Medium

Low

Medium

Low

Low

Low

Low

Low

High

Medium

High

Threshold

Threshold

Threshold

Threshold

Threshold

Total costs (based on 
assumed exposure) 

Total costs (based on 
assumed exposure) 

Total costs (based on 
assumed exposure) 

Total costs (based on 
assumed exposure) 

0,25

0,2

0,3

0,4

0,5

(1)

(2)

(3)=(2)*52,81*2

(6)

(7)=(6)*52,81*2

(8)

(9)=(8)*52,81*2

(10)

11)=(10)*52,81*2

223

73

58

58

58

223

58

73

223

223

73

58

73

223

58

58

73

58

73

58

58

58

58

58

223

73

223

675

221

175

175

175

675

175

221

675

675

221

175

221

675

175

175

221

175

221

175

175

175

175

175

675

221

675

71.264

23.328

18.535

18.535

18.535

71.264

18.535

23.328

71.264

71.264

23.328

18.535

23.328

71.264

18.535

18.535

23.328

18.535

23.328

18.535

18.535

18.535

18.535

18.535

71.264

23.328

71.264

446

146

116

116

116

446

116

146

446

446

146

116

146

446

116

116

146

116

146

116

116

116

116

116

446

146

446

47.107

15.421

12.252

12.252

12.252

47.107

12.252

15.421

47.107

47.107

15.421

12.252

15.421

47.107

12.252

12.252

15.421

12.252

15.421

12.252

12.252

12.252

12.252

12.252

47.107

15.421

47.107

257

84

67

67

67

257

67

84

257

257

84

67

84

257

67

67

84

67

84

67

67

67

67

67

257

84

257

903.100

596.964

27.177

8.896

7.068

7.068

7.068

27.177

7.068

8.896

27.177

27.177

8.896

7.068

8.896

27.177

7.068

7.068

8.896

7.068

8.896

7.068

7.068

7.068

7.068

7.068

27.177

8.896

27.177

344.402

223

73

58

58

58

223

58

73

223

223

73

58

73

223

58

58

73

58

73

58

58

58

58

58

223

73

223

23.553

7.710

6.126

6.126

6.126

23.553

6.126

7.710

23.553

23.553

7.710

6.126

7.710

23.553

6.126

6.126

7.710

6.126

7.710

6.126

6.126

6.126

6.126

6.126

23.553

7.710

23.553

298.482

 
 
 
 
 
 
17. 

ANNEX  9  –  TABLE  PROVIDING  AN  OVERVIEW  OF  THE  SCOPE  OF  PREFERRED 
OPTIONS 

The below table shows the instruments which are in scope for each of the preferred options 
(indicated with a 'Y'). 

Financial Instruments 

Preferred options 

Transparency 

Notification to competent authorities of significant net 
short positions in shares 

Requirement to mark a short order on a trading venue as 
"short" 

s
e
r
a
h
S
U
E

Y 

Y 

Public disclosure of significant net short positions in shares 

Y 

Notification to competent authorities of significant net 
short positions in sovereign debt and credit default swaps 

Information provided (quarterly) to ESMA 

Uncovered Short Sales 

Restrictions on uncovered short sales 

Buy in procedures and fines for late settlement 

Exemptions 

Exemption when the principle trading venue is outside the 
Union 

Exemption for market making and primary market 
operations 

Powers in exceptional situations 

Disclosure in an exceptional situation 

Restrictions on short selling in an exceptional situation 

- 

Y 

Y 

Y 

Y 

Y 

- 

Y 

s
e
r
a
h
S

U
E
o
t

g
n
i
t
a
l
e
r

s
e
v
i
t
a
v
i
r
e
D

Y 

- 

Y 

- 

Y 

- 

- 

Y 

Y 

- 

Y 

t
b
e
D
n
g
i
e
r
e
v
o
S
U
E

- 

- 

- 

Y 

Y 

Y 

Y 

- 

Y 

- 

Y 

U
E
o
t

g
n
i
t
a
l
e
r

s
e
v
i
t
a
v
i
r
e
D

s
r
e
u
s
s
I
n
g
i
e
r
e
v
o
S

U
E

o
t

g
n
i
t
a
l
e
r

S
D
C

s
r
e
u
s
s
I
n
g
i
e
r
e
v
o
S

l
a
i
c
n
a
n
i
F

s
t
n
e
m
u
r
t
s
n
I

r
e
h
t
O

- 

- 

- 

Y 

Y 

- 

- 

- 

Y 

- 

Y 

- 

- 

- 

Y 

Y 

- 

- 

- 

Y 

- 

Y 

- 

- 

- 

- 

- 

- 

- 

- 

Y 

Y 

- 

EN 

114 

   EN 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Restrictions on Credit Default Swap transactions in an 
exceptional situation 

Power to temporarily restrict short selling of financial 
instruments in case of a significant price fall (10%) 

- 

Y 

- 

Y 

- 

Y 

- 

Y 

Y 

Y 

- 

Y 

EN 

115 

   EN