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The UK government has launched a public consultation to review short selling practices in the UK market and whether there is a case for reforming the UK Short Selling Regulation.
Short selling is currently regulated in the UK by the Short Selling Regulation (SSR), the UK enactment of the EU Short Selling Regulation incorporated into UK law under the European Union (Withdrawal Act) 2018.
This applies to short-sale of ‘publicly traded’ securities, UK sovereign debt and the use of credit default swaps in relation to UK sovereign debt. The SSR also includes short trades applied through use of derivatives.
The European Union’s SSR was introduced in 2012 in reaction to concerns around short-selling of equities and euro-area sovereign debt highlighted by the 2008 financial crisis.
Prior to this, the UK had “standalone” short selling regimes in place. The Financial Services Authority (FSA) introduced a temporary short selling ban and a public disclosure regime for UK financial sector companies in 2008.
It put a permanent public disclosure regime in place in 2010 for securities of a publicly traded company, where investors were required to report a short position when this reached 0.25 per cent of issued share capital.
Through its review of SSR, announced today, the government intends to gauge whether the UK’s approach to regulating the short selling of shares reflects the current circumstances of the UK markets post-Brexit.
This government’s call for evidence is limited to short-sales in shares admitted to trading on a regulated market or multilateral trading facility (MTF) and does not extend to short selling provisions for UK sovereign debt, UK sovereign credit default swaps and other SSR content. Instead, the UK government will address these remaining provisions as part of a later regulatory review.
The call for evidence relates particularly to restrictions on uncovered short sales, position-reporting and disclosure requirements, emergency intervention powers extended to the Financial Conduct Authority (FCA) under SSR, market-maker exemptions and treatment of third-country shares.
Relating to regulation of ‘naked shorts’, SSR requires trading parties to cover their short selling transactions and sets out requirements regarding how these covering arrangements should be applied, including agreeing to borrow securities or using ‘locate’ arrangements.
As part of its review, the government asks for feedback on whether the current arrangements for covering short selling trades are appropriate in offering protection against settlement risks and disorderly markets.
In addressing existing position reporting and disclosure requirements under SSR, the government asks for evidence about whether the costs of reporting borne by firms are proportionate and whether changes are needed to reduce this burden. The government notes that lowering the reporting threshold from 0.2 per cent to 0.1 per cent has significantly increased the FCA’s visibility over the number of companies subject to net short positions and the size of those net short positions.
The SSR also requires persons to publicly disclose to the market when they have a net short position that exceeds 0.5 per cent of issued share capital in a publicly traded company and to provide further disclosures for each 0.1 per cent incremental increase above this threshold.
The aim of this reporting regime is to provide investors with information and transparency on how short selling impacts securities pricing. However, the government observes that the UK’s public disclosure regime may in some cases discourage investors from taking out large net short positions, given that they will need to identify themselves to the public. Consequently, it asks for feedback regarding whether this disclosure regime should be amended.
Additionally, the government is seeking views on the current functioning of the market maker exemption and whether there are opportunities to streamline this exemption framework.
For example, under the SSR market makers are exempt from restrictions on uncovered short selling and the requirement to report net short positions to the FCA and to the market. To qualify for an exemption, market makers are required to submit a written notification to the FCA at least 30 calendar days before they intend to use it.
With respect to emergency intervention powers, the SSR provides the FCA with powers to restrict short selling in certain circumstances to protect the orderly functioning of the market. When the price of an instrument falls significantly during a trading day, the FCA can apply a short-term ban on short selling in that instrument on the next day of trading. The FCA can also apply a ban of up to three months on the short selling of a financial instrument in exceptional circumstances.
The government asks for public feedback on whether these FCA powers are appropriate and whether changes could be made to improve the functioning of short selling bans. It observes that global opinion is mixed regarding the efficacy of previous bans, suggesting that in some cases these have done little to reduce price declines and volatility, while having a negative impact on market liquidity and limiting participants’ ability to undertake hedging activities.
Alongside these provisions, the government is seeking views on the current arrangements for overseas shares, or third-country shares, that are exempt from SSR and how these arrangements could be made more effective, while reducing any burden this places on firms.
More generally, the government solicits feedback on whether changes to the UK short selling regime would increase the burden on firms that operate in multiple jurisdictions and may be required to implement and maintain different systems and controls.
Respondents are asked to submit their evidence to this consultation process by 23.59 on 4 March 2023.
