In September 2008, at the height of the financial crisis, the Member States of the European Union (as well as some third countries like the United States and Japan) saw a risk of collapse in share prices in short selling practices, particularly within the financial institutions, which could cause systemic risks.

In Luxembourg, the CSSF reacted by publishing two press releases in September 20081 prohibiting naked short sales where their underlying consisted of shares in a credit establishment or insurance undertaking traded on a regulated market of the Luxembourg Stock Exchange (excluding those securities admitted to trading on the Euro MTF).

Given the lack of cohesion within the Member States, the European Union responded by adopting Regulation (EU) No. 236/2012 of the European Parliament and of the Council of 14 March 2012 on short selling and certain aspects of credit default swaps (the "SSR")2. Although certain indirect provisions have applied since March 2012, the SSR took effect on 1 November 2012 and the positions adopted in 2008 by the CSSF are repealed as from this date.

As the European framework takes the legislative form of a regulation, this ensures that provisions directly imposing obligations on private parties to notify and disclose net short positions relating to certain instruments and restricting uncovered short selling are applied in a uniform manner throughout the European Union. Moreover, the SSR confers powers on the European Securities and Markets Authority ("ESMA")3 to coordinate measures taken by the competent authorities or to take measures itself.

The scope of the SSR is as broad as possible to provide for a preventive regulatory framework to be used in exceptional circumstances with a proportionate response to the risks that short selling of different instruments could represent. It is therefore only in the case of exceptional circumstances that competent authorities and ESMA will be entitled to take measures concerning all types of financial instruments (see the scope of the SSR under paragraph 2 below), going beyond the permanent measures that only apply to particular types of instruments (see the transparency regime under paragraph 3 below) where there are clearly identified risks that need to be addressed.

1. What is the definition of short selling in the SSR?

The SSR provides a standard definition of short selling.

According to Article 2.1.b) of the SSR, a "short sale" in relation to a share or debt instrument means any sale of the share or debt instrument which the seller does not own at the time of entering into the agreement to sell including such a sale where at the time of entering into the agreement to sell the seller has borrowed or agreed to borrow the share or debt instrument for delivery at settlement.

The following transactions are not considered as short sales within the meaning of the SSR:

  1. a sale by either party under a repurchase agreement where one party has agreed to sell the other a security at a specified price with a commitment from the other party to sell the security back at a later date at another specified price;
  2. a transfer of securities under a securities lending agreement; or
  3. entry into a futures contract or other derivative contract where it is agreed to sell securities at a specified price at a future date.

2. What is the scope of application of the SSR?

Article1.1 of the SSR states that this regulation applies (i) to all financial instruments that are admitted to trading on a trading venue in the Union, including such instruments when trading outside a trading venue, (ii) to derivatives that relate to these financial instruments or to an issuer of such a financial instrument, and (iii) to debt instruments issued by a Member State or the Union and derivatives that relate or are referenced to debt instruments issued by a Member State or the Union4 .

The key point is therefore the place of trading which must be within the European Union. Indeed neither the location of the short sale transaction nor of the person effecting it is relevant.

However, the transparency requirements detailed below do not apply to all the financial instruments referred to above but only to shares which are admitted to trading on a regulated market or on a multilateral trading system5 (except if the main venue is in a third country). For sovereign debts and sovereign credit default swaps the notification and publication requirements provided under the SSR apply if they are issued by a Member State or by the Union.

3. Transparency of net short positions

The SSR introduces a system of transparency of significant net short positions in shares which are admitted to trading on a regulated market or a multilateral trading system (except if the main trading venue is in a third country) or of significant net short position in relation to sovereign debt issued by a Member State or the Union where certain thresholds of net short positions are exceeded or not reached.

The transparency regime on shares is a two-tier model of private and public reporting.

Any net short position in shares which exceeds or falls below the threshold of 0.2% of the share capital issued by an entity concerned, and each 0.1% above that threshold, must be notified to the competent authority which, for Luxembourg, is the CSSF. The notification requirement becomes a publication requirement when the threshold of 0.5% of capital issued by the entity concerned is exceeded, and each 0.1% above that.

A notification system is also implemented for significant net short positions on sovereign debt and for uncovered positions in sovereign credit default swaps ("CDS") when certain thresholds are reached. ESMA shall publish on its website the notification thresholds applicable to each Member State.

The SSR provides that the above transparency obligations shall not apply to shares of a company admitted to trading on a trading venue in the Union where the principal venue for the trading of the shares is located in a third country (Article 16 of the SSR). Commission Delegated Regulation No. 826/2012 (mentioned under footnote 2) provides for a method of calculation of turnover to determine the principal trading venue for a share.

The methods of notification and publication are provided in Commission Delegated Regulation No. 826/2012 and Commission Implementing Regulation No. 827/2012 (mentioned under footnote 2) and must be adopted and detailed by each competent authority.

On 30 October 2012, the CSSF published the Circular 12/548 on the entry into force of the SSR. This circular aims at providing practical details and guidance as regards certain aspects in relation to the notification or disclosure of significant net short positions to the CSSF in accordance with Articles 5 to 9 of the SSR, the exemption for market making activities and primary market operations under Article 17 of the SSR and the publication, by ESMA and by the CSSF, of relevant information in relation to the application of the SSR.

4. Restrictions on uncovered short sales

The SSR prohibits any uncovered short sales in shares unless one of the following conditions is met:

  1. the natural or legal person has borrowed the share or has made alternative provisions resulting in a similar legal effect;
  2. the natural or legal person has entered into an agreement to borrow the share or has another absolutely enforceable claim under contract or property law to be transferred ownership of a corresponding number of securities of the same class so that settlement can be effected when it is due;
  3. the natural or legal person has an arrangement with a third party under which that third party has confirmed that the share has been located and has taken measures vis-à-vis third parties necessary for the natural or legal person to have a reasonable expectation that settlement can be effected when it is due.

The same restrictions are applicable to uncovered short sales in sovereign debt. There also exist restrictions on uncovered CDS.

Commission Implementing Regulation No. 827/2012 (mentioned under footnote 2) specifies in particular which are the agreements, arrangements and measures to ensure adequately that the instruments are available for settlement.

5. Exemptions for market making activities and for authorised primary dealer activities

The transparency mechanisms of significant net short positions and of restrictions on uncovered short sales do not apply to transactions carried out on financial instruments (which include derivatives) due to market making activities and authorised primary dealer activities.

According to Article 2(1)(k) of the SSR, "market making activities" means the activities of an investment firm, a credit institution, a third-country entity, or a firm as referred to in point (1) of Article 2(1) of Directive 2004/39/EC, which is a member of a trading venue or of a market in a third country, the legal and supervisory framework of which has been declared equivalent by the Commission pursuant to Article 17(2) where it deals as principal in a financial instrument, whether traded on or outside a trading venue, in any of the following capacities:

  1. by posting firm, simultaneous two-way quotes of comparable size and at competitive prices, with the result of providing liquidity on a regular and ongoing basis to the market;
  2. as part of its usual business, by fulfilling order initiated by clients or in response to clients' request to trade;
  3. by hedging positions arising from the fulfilment of tasks under points i) and (ii).

According to the above definitions, the CSSF shall be the competent authority in Luxembourg for investment firms and credit institutions as defined in the Luxembourg Law of 5 April 1993 on the financial sector, as amended, and for firms as referred to in point (l) of Article 2(1) of Directive 2004/39/EC where they have their registered office, their head office or their domicile in Luxembourg.

Article 2(1)(n) defined "authorised primary dealer" as a natural or legal person who has signed an agreement with a sovereign issuer or who has been formally recognised as a primary dealer by or on behalf of a sovereign issuer and who, in accordance with that agreement or recognition, has committed to dealing as principal in connection with primary and secondary market operations relating to debt issued by that issuer. In Luxembourg the CSSF shall then be the competent authority in relation to the sovereign debt issued by the Grand-Duchy of Luxembourg, the European Investment Bank, the European Financial Stability Facility and the European Stability Mechanism.

The relevant concerned authorities shall then notify their request of exemption directly to the CSSF in accordance with the procedure set forth by the CSSF in the Circular 12/548.

6. Powers of competent authorities and of ESMA in exceptional circumstances

The SSR also provides that the competent authorities and ESMA may, in exceptional circumstances, adopt specific notification and publication procedures. Such specific measures may apply to all financial instruments as opposed to the transparency regime which apply to only certain financial instruments.

Footnotes

1. The CSSF press release dated 19 September 2008 relating to the ban on naked short selling and the CSSF press release dated 29 September 2008 providing details concerning the ban on naked short selling.

2. For consistent application of the SSR, the Commission has adopted a package of four implementing measures specifying technical aspects of certain key issues of the SSR: (i) Commission Delegated Regulation (EU) No 826/2012 of 29 June 2012 supplementing Regulation (EU) No 236/2012 of the European Parliament and of the Council with regard to regulatory technical standards on notification and disclosure requirements with regard to net short positions, the details of the information to be provided to the European Securities and Markets Authority in relation to net short positions and the method for calculating turnover to determine exempted shares; (ii) Commission Implementing Regulation (EU) No 827/2012 of 29 June 2012 laying down implementing technical standards with regard to the means for public disclosure of net position in shares, the format of the information to be provided to the European Securities and Markets Authority in relation to net short positions, the types of agreements, arrangements and measures to adequately ensure that shares or sovereign debt instruments are available for settlement and the dates and period for the determination of the principal venue for a share according to Regulation (EU) No 236/2012 of the European Parliament and of the Council on short selling and certain aspects of credit default swaps; (iii) Commission Delegated Regulation (EU) No 918/2012 of 5 July 2012 supplementing Regulation (EU) No 236/2012 of the European Parliament and of the Council on short selling and certain aspects of credit default swaps with regard to definitions, the calculation of net short positions, covered sovereign credit default swaps, notification thresholds, liquidity thresholds for suspending restrictions, significant falls in the value of financial instruments and adverse events; and (iv) Commission Delegated Regulation (EU) No 919/2012 of 5 July 2012 supplementing Regulation (EU) No 236/2012 of the European Parliament and of the Council on short selling and certain aspects of credit default swaps with regard to regulatory technical standards for the method of calculation of the fall in value for liquid shares and other financial instruments.

3. ESMA has been established by Regulation (EU) No 1095/2010 of the European Parliament and of the Council.

4. The financial instruments and derivative instruments as referred to in the SSR are listed in the Appendix to the 2004/39/EC Directive ("MiFID Directive").

5. The material scope of transparency obligations is therefore broader than that initially adopted by the CSSF in 2008 because it is no longer confined to shares of credit institutions or insurance undertakings whose securities are admitted to the negotiation on a regulated market of the Luxembourg Stock Exchange but concern all the shares admitted to the regulated and non-regulated markets of the Luxembourg Stock Exchange.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.