REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL on the evaluation of the Regulation (EU) No 236/2012 on short selling and certain aspects of credit default swaps
Date: 2013-12-13
Institutions: European Commission
Subjects: capital market, debt, financial institution, financial instrument, financial legislation, public debt













EUR-Lex - 52013DC0885 - EN











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52013DC0885

REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL on the evaluation of the Regulation (EU) No 236/2012 on short selling and certain aspects of credit default swaps /* COM/2013/0885 final */









REPORT FROM THE COMMISSION TO THE
EUROPEAN PARLIAMENT AND THE COUNCIL
on the evaluation of the Regulation (EU)
No 236/2012 on short selling and certain aspects of credit default swaps
(Text with EEA relevance)
1.           Introduction 
This report to
the European Parliament and the Council (hereinafter: “Report”) provides
for the evaluation of the Regulation on short selling and certain aspects of
credit default swaps (EU) No 236/2012 (hereafter: “SSR”). The
European Commission is required under Article 45 SSR to report to the European
Parliament and the Council on the appropriateness and impact of certain
provisions of the SSR. This report covers the points listed in Article 45
SSR.
This Report was
prepared in light of discussions with the competent authorities and ESMA. On 22
October 2012 the Commission formally mandated ESMA to carry out a quantitative
analysis of the available short selling data and a consultation of competent
authorities and market participants. On the basis of this work, ESMA issued its
technical advice on the evaluation of the SSR on 3 June 2013
(hereinafter: “ESMA’s Report”).[1]

2.           Appropriateness of the notification and disclosure
procedures
2.1.        Notification and public disclosure of significant net
short positions in shares 
According to ESMA’s findings, between 1
November 2012 and 28 February 2013, there were 12,603
notifications reported to competent authorities on 970 different shares in
18 Member States. Notably, 74% of these notifications were within the 0.2% and
0.5% thresholds; the other 26% stood above 0.5% and were therefore disclosed to
the public. During that period only a few holders shorted a large number of
shares, with 75% of holders shorting seven different shares or less. Short
position holdings were quite concentrated, as ten entities held more
than 28% of all the positions reported in the period (ESMA’s Report, § 17
and 19).
ESMA considers that the current thresholds
of the SSR are well-suited to generate both meaningful information for
competent authorities and the market as well as a proportionate compliance
burden on investors. ESMA considers that the current reporting thresholds and
incremental levels for shares are appropriate and should remain unchanged
(ESMA’s Report, § 31 and 32). 
The Commission concurs with ESMA’s conclusion
that the notification and public disclosure thresholds of significant net
positions in shares appear to be well-calibrated and appropriate and sees, at
this stage, no compelling evidence for the need to change them or the current
methodology for calculating the net short positions in shares.
2.2.        Reporting of significant net short positions in
sovereign debt and notification of uncovered positions in sovereign CDS 
Between 1 November 2012 and 28 February
2013, ESMA has established that only a small number of notifications (148) were
made to competent authorities on 13 sovereign entities in 11 Member
States. There were 26 holders that reported 39 short positions, on which 109
modifications occurred during the period (ESMA’s Report, § 50 and 51).
ESMA considers that the very low number of
notifications received on sovereign debt, compared to the number of
notifications received on shares, might mean that the threshold was set too
high, or could be attributed to the use of a duration adjusted method for this
reporting. ESMA considers the nominal method more appropriate than the duration
adjusted method for calculating net short positions in sovereign debt. ESMA
suggests that, should the duration adjusted approach be maintained, then the
initial thresholds would need to be revised accordingly. ESMA also
suggests moving to an annual review instead of the current quarterly review
(ESMA’s Report, § 52 and 57-59).
The Commission takes note of the relatively
low level of short selling notifications in sovereign debt compared to the
number of notifications received on shares, as well as the pros and cons of
both the duration adjusted and nominal methods. However, given the limited
period of time since the application of the SSR and the consequent lack of
data, the Commission sees, at this stage, no compelling evidence justifying
revisions of the SSR framework in this area. 
3.           Impact of Individual disclosure requirements
ESMA reports that 224 holders publicly
disclosed 1090 short positions on 427 shares, with the bulk of disclosures from
the UK, followed by France and Sweden. Among the 3,508 notifications made
public by these 224 holders, 90% were from holders domiciled in the UK or the US, and the ten biggest holders accounted for 37.5% of those published notifications (ESMA’s Report, p. 60-62). 
Competent authorities considered the
individual reporting thresholds to be appropriate, but they received mixed
views from market participants. ESMA also comments that
market participants may tend to avoid crossing the notification threshold so as
to remain under the 0.5% thresholds to avoid disclosing information on
short selling activities. (ESMA's Report, p§ 22 and 29).
In terms of the general impact of the
Regulation, ESMA notes that overall there was a slight decline in the
volatility of EU stocks compared to US stocks. There were mixed effects on
liquidity and price discovery seems to have decreased compared to the period
before the entry into force of the Regulation. However, ESMA cautions that the
analysis should be interpreted with due care given the short time span, the
empirical limits and the difficulty in identifying the specific effects of the
Regulation (ESMA’s Report, §10-11).
As noted in section 2.1, ESMA’s Report does
not recommend any changes to the disclosure thresholds. The Commission agrees
with ESMA that no changes in the individual disclosure requirements are
required.
4.           Appropriateness of
direct, centralised reporting to ESMA
The majority of competent authorities would
prefer not to introduce a centralised reporting mechanism and prefer to
maintain current arrangements (ESMA’s Report, § 64). They argue that a
centralised EU-wide reporting mechanism could potentially make national
monitoring and enforcement more difficult and less effective. In contrast, a
minority of competent authorities and some market participants support and
acknowledge the benefits of a centralised reporting mechanism (ESMA’s Report,
§ 62 and 64). ESMA recommends no change to the SSR and its implementing
texts in relation to the reporting mechanism (ESMA’s Report, § 66). 
In light of the above, the Commission
considers that the current system of reporting at national level is functioning
well and that direct centralised reporting does not appear, at this stage, to
offer substantial benefits. 
5.           Restrictions and requirements on the uncovered short
selling in shares, sovereign debt and sovereign CDS
5.1.        Restrictions on uncovered short selling of shares and
sovereign debt
ESMA evaluated the operation of the
restrictions on uncovered short selling by assessing the impact on securities
lending and the number of settlement fails. ESMA reports that activity in
securities lending markets has been lower since the entry into force of the
SSR, though it has recovered since January 2013. However, ESMA points out that
regulatory data on securities lending is non-existent, so this analysis may not
be comprehensive enough. 
The restrictions would be expected to
reduce settlement fails. Indeed, ESMA reports that settlement fails seem to
have decreased since the entry into force of the Regulation, evidenced by fewer
settlement fails on European equities based on volumes and value, whereby
average settlement fails fell respectively by 0.5 and 1 percentage points
(ESMA’s Report, § 77). ESMA concludes that the application of the SSR was
followed by an increase in settlement discipline (ESMA’s Report, p. 21-23. See
also section 5.3).
Given the above empirical evidence, ESMA
suggests that no substantial changes in this area are warranted at this stage.
However, ESMA proposes some changes to Articles 12 and 13 SSR to enable short
sellers to obtain the confirmations necessary to undertake a short sale from
parties within the same legal entity provided that those parties meet the
necessary conditions, and some refinements in the Commission Implementing
Regulation (EU) No 827/2012 (ESMA’s Report, §
83-85).
The Commission concurs with ESMA’s
conclusions that no major revisions of the SSR framework in this area are
required at this stage. 
5.2.        Restrictions and requirements pertaining to uncovered
sovereign CDS transactions 
By measuring the effect of the uncovered
CDS ban on sovereign borrowing conditions by CDS spreads and sovereign bond
yields, ESMA has observed a slight decrease in Member States’ sovereign CDS spreads
after the introduction of the prohibition on uncovered sovereign CDS
transactions. The effect of the ban was found to result in a reduction of
around 26 basis points in the CDS spread (ESMA’s
Report, § 100). ESMA concluded that as a whole, the entry into application of
the SSR did not seem to have had a compelling impact on the activity in the
sovereign CDS market, with the exception of sovereign CDS indices, for which a
sharp decline was observed. ESMA points out that there seems to have been no noticeable
adverse effects on EU sovereign debt markets. However, there has been a decline
in activity for sovereign CDS in a few Member States and sovereign CDS indices
(ESMA’s Report, § 112).
Overall, ESMA does not see compelling
evidence warranting major changes in the SSR provisions dealing with sovereign
CDS at this stage, noting that it may be too early to draw firm conclusions
(ESMA’s Report; § 112). 
The Commission is of the view that there
was only a very short period of experience of the effect of the SSR on which to
base these conclusions. Given the above, the Commission considers that the
restrictions and requirements on uncovered sovereign CDS transactions remain
appropriate. 
5.3.        Settlement
discipline including buy-in procedures 
Market participants reported a general
improvement in settlement discipline in shares since the entry into application
of the SSR, Overall, the number of buy-ins and buy-in
attempts across the Union has increased by 35% since the application of the
SSR. However this increase could largely be attributed to one particular Member State.
ESMA considers that the settlement
discipline requirements, notably the buy-in procedures, could be more
appropriately addressed in a single, horizontal piece of legislation (ESMA’s
Report, § 88-91). In particular, ESMA is of the view that the forthcoming
Regulation on central securities depositories (CSD)[2] provides a more
efficient tool to set out a more detailed regime and to ensure a level-playing
field in the application of the buy-in and settlement penalties procedures.
The Commission agrees that the settlement
discipline requirements, notably the buy-in procedures, could be more
appropriately dealt with in the forthcoming Regulation on CSD, provided that a
more comprehensive horizontal approach is achieved.
5.4.        Other
aspects related to the operation of restrictions 
Based on the feedback from the market
participants and competent authorities on the improvements in settlement
performance, ESMA considers that the introduction of the restrictions on
uncovered short selling had a noticeable impact in reducing the incidence of
settlement failures in share transactions. Regarding
the impact of the “locate rule”, ESMA’s analysis of data on securities lending
during 2012 and the first part of 2013 shows that activity in securities
lending markets has been lower since the entry into application of the SSR,
though it has recovered since January 2013. 
Overall, ESMA takes the view that no
substantial changes to the requirements in this area are warranted at this
stage. However, ESMA proposes making some minor changes in the details of
Articles 12 and 13 SSR (such as allowing internal lending desks rather
than third parties) to provide locates and revisiting the definition of liquid
shares for the purpose of locate arrangements at a later stage (ESMA’s Report, § 83).
The Commission agrees with ESMA’s
conclusion that the operation of the restrictions and requirements related to
the transparency of net short positions and uncovered short sales do not at this
stage suggest any evidence of major deficiencies or malfunctionning of the SSR
in this area. 
6.           Functioning of the market
making exemption under the SSR
The application of the market making
exemption under the SSR is linked to the operation of obligations contained in
Chapters II and III of the SSR and therefore to the evaluation carried out in
this Report. ESMA Guidelines on market making exemption have been applied since
April 2013. 
ESMA reports that the majority of competent
authorities considered that the exemption would allow liquidity provision
without permitting circumvention, however some thought it could lead to a
decline of liquidity provision. Market participants expressed concerns that the
limited scope of the exemption restricted their ability to offer OTC market
making in instruments such as interest rate swaps and non-listed
derivatives (ESMA’s Report, § 140- 144). 
Competent authorities generally considered
the procedure for notifications of intent to use the exemption to be
appropriate, although a number were concerned about a heavy workload. Market
participants considered that the requirement to notify on an instrument by
instrument basis was cumbersome and impracticable. Concerns were also expressed
about the risks of an uneven playing field as a result of different authorities
processing notifications for exemptions at different speeds (ESMA’s Report, §
145-146).
ESMA proposes to change the text of the SSR
and re-consider the scope of the market making exemption, as well as making
certain changes in either technical standards or delegated acts (ESMA’s Report,
§ 149). In particular, ESMA recommends revisiting the scope of, and the
conditions for, the exemption while still respecting the underlying purpose and
rationale of the SSR (ESMA’s Report, § 152-156). The Commission considers, however, that the
concerns expressed in ESMA's Report on the scope of, and the conditions for,
the market making exemption can only be meaningfully assessed once an
appropriate period of time has elapsed since the entry into force of the SSR so
sufficient experience in applying the SSR can support any proposal for
revision.
Furthermore, according to ESMA Guidelines
compliance table, published on 19 June 2013, regarding the exemption for market
making activities and primary market operations under the SSR (ESMA/2013/765),
the competent authorities of five Member States have explained their
non-compliance with aspects of the Guidelines by referring to their divergent
views on a number of issues, such as the scope of the covered instruments and
the conditions for granting the market maker exemption. [3] 
The Commission cautions that the
non-compliance with the ESMA Guidelines by some competent authorities is bound
to create a situation whereby the SSR is applied in a divergent manner,
resulting in an unlevel playing field across the Union. In addition, different
criteria applied to the reassessment of previously granted market maker
exemptions can also lead to a divergent application of that exemption. These
divergences may consequently distort competition and diminish the effectiveness
of the SSR framework.
The Commission considers that a consistent
application of the SSR framework and, in particular, of the market making
exemption in all Member States is crucial in ensuring a level playing field and
consistency of market practices across the Union. The creation of an unlevel
playing field in the Union could undermine the main objective of the
Regulation, i.e. ensuring the proper functioning of the internal market
for financial services, and ensuring a high level of consumer and investor
protection. 
Against this background, the Commission
sees, at this stage, no compelling evidence for revisions of the SSR framework
in this area. Where the Commission establishes that the SSR, and in particular
the market making exemption, is applied in a manner which is in breach of the
SSR, the Commission will take appropriate follow-up measures.
7.           Intervention powers under
the SSR 
According to Article 23 SSR, the competent
authorities have the right to take certain emergency measures in the event of a
significant price fall in a financial instrument. So far this power to
temporarily restrict short selling or otherwise limit transactions in a
financial instrument has been exercised by two Member States only (Italy and Portugal). According to the feedback of some market participants, the bans created
confusion and uncertainty for participants and led to an immediate impact on
liquidity and price efficiency. Furthermore, the measure caused investigative
costs for market participants to seek the information due to differences in the
content, in timing of the releases during the trading day in the concerned
countries and due to lack of clarity about the scope of instruments (ESMA’s
Report; § 190). 
It has come to the attention of the
Commission that in cases where a competent authority imposed a temporary
“significant price fall” short selling ban on certain shares, similar bans on
the same shares were not imposed by competent authorities of other Member
States in which those shares were also traded, or they adopted divergent
measures. This resulted in the ban being in force in
some Member States and not being applied in other Member States. In certain
other cases, even different competent authorities within one Member State have acted differently in deciding whether or not to impose a short selling ban
applied by a Member State. 
ESMA suggests that for the Article 23
measures to be workable, less complex and less resource intensive, the competent
authorities of the most relevant market in terms of liquidity for a particular
instrument should be allowed to exercise their judgment as to if and when a
temporary measure to ban short selling or limit trading in a particular
instrument is necessary, without having to implement a mechanism based on
thresholds for significant falls in price (ESMA’s Report, § 209).
The Commission is of the view that the SSR
provides competent authorities with an effective and complete framework of
rules to apply short selling bans in a consistent and efficient manner.
Competent authorities should therefore ensure that a consistent approach is
taken and their powers are effectively used in a way that avoids potential
inconsistent applications of short selling bans, thus contributing to the
achievement of the objectives sought by the SSR. For these purposes, competent
authorities must ensure that the procedure set out in Article 26(4) SSR is
fully observed, enabling ESMA to inform all other relevant competent
authorities of a banning measure taken in accordance with Article 23 SSR. The
observance of this procedure should also enable competent authorities to assess
whether measures taken by other competent authorities are consistent to each
other.
Regarding the appropriateness of thresholds
specified in Article 23 SSR and Article 23 of the Commission Delegated
Regulation (EU) No 918/2012, ESMA considers that not all current thresholds set
to identify a significant fall in prices for all categories of instruments
should be maintained and that some thresholds should be changed or removed
(ESMA’s Report, § 210-211). According to ESMA, the thresholds for
corporate and sovereign bonds should be reconsidered or removed, and no
thresholds are necessary for listed UCITS (other than ETFs) or for commodity
derivatives (ESMA’s Report, § 211).
Given the limited experience with the
application of these thresholds, the Commission does not deem it necessary to
revise them or to reconsider thresholds for significant price falls for UCITS
and commodity derivatives.
With respect to
emergency measures in case of adverse events or developments which constitute a
serious threat to financial stability or market confidence under Articles 18,
19, 20 and 21 SSR, ESMA is of the view that the provisions of the SSR are
generally necessary and appropriate. The Commission concurs.
8.           Conclusions 
The Commission considers that, based on the
limited data available so far, it can be said that the SSR has had a positive
impact in terms of greater transparency of short sales and reduced settlement
failures, and a relatively mixed economic impact. There is no compelling
evidence of a substantial negative impact of the SSR in terms of reduced
liquidity of sovereign CDS. ESMA’s Report does not suggest any major negative economic
impacts of the SSR which, in the Commission’s view, would warrant a revision of
the SSR in the short term. Overall, the empirical evidence available shows that
the SSR has had some beneficial effects on volatility, mixed effects on
liquidity and led to a slight decrease in price discovery.
As ESMA itself notes, the conclusions in
its Report should be taken with caution given the short time available for
evaluation since the SSR entered into application and the consequent lack of
data. The competent authorities and the market participants acknowledge that
this short time scale and limited data backed assessment make it difficult to
draw precise conclusions as to whether the SSR’s goals of improving the
conditions of market functioning and ensuring a high level of investor
protections have been achieved (ESMA’s Report, § 12-13). In addition, the
Market Making Guidelines adopted by ESMA have only been applicable since April
2013. 
Although ESMA has made some recommendations
for adjustments to the SSR, notably concerning the locate rule, market making
exemption and the power of competent authorities to impose short term bans,
ESMA has advised the Commission to revisit the assessment of the SSR and its
implementing texts at a later stage, once more data and greater experience will
be available. ESMA has also drawn the Commission’s attention to the cost
implications that changes in the legislative framework so soon after its entry
into application might have on investors and on competent authorities. Finally,
the overall quantitative analysis of the effects of the SSR presented in ESMA’s
Report is subject to certain qualifications that have substantial effect on the
way in which the impact of the SSR is to be interpreted. In particular, the
methods used by ESMA in its technical assessment of the SSR are subject to
model risk and empirical limits.[4]
According to ESMA, there is also a risk that the analysis captures nevertheless
certain external factors that may distort the findings outlined therein.
The Commission is therefore of the view
that it is too early, based on available evidence, to draw firm conclusions on
the operation of the SSR framework which would warrant a revision of the
legislation at this stage.[5]
The Commission will, therefore, continue monitoring the application of the SSR.
In order to ensure a smooth functioning of the short selling legal framework,
the Commission considers that a new evaluation of the appropriateness and
impact of the SSR, similar in scope to that specified in Article 45 SSR, could
be carried out based on more empirical data and evidence and once the competent
authorities have accumulated sufficient regulatory experience of applying the
SSR. Such an evaluation could be concluded by 2016, i.e. three years
after the entry into application of the SSR. Such an analysis of the effects
and impact of the SSR should be based on the input of ESMA, the analysis of
available data and the feedback of competent authorities and market
participants.
[1]               Final Report. ESMA’s technical advice on the
evaluation of the Regulation (EU) 236/2012 on short selling and certain aspects
of credit default swaps. ESMA/2013/614. 
[2]               The Commission's proposal (COM(2012) 73 final) for a
Regulation on improving securities settlement in the European Union and on central
securities depositories (CSDs) and amending Directive 98/26/EC of 7 March 2012
is currently under consideration by the European Parliament and the Council.
[3]               On 16 June 2013, ESMA published a table of compliance
table with ESMA’s Market Making Guidelines (ESMA/2013/765). 
[4]               This qualification was also emphasised in ESMA’s
Report, § 8.
[5]               In this context, it is important to note the pending
case before the Court of Justice of the European Union in case C-270/12 in
which the United Kingdom sought the annulment of Article 28 of the SSR.