Traders warn rules on short selling would hurt liquidity

Proposed new short selling rules in Europe drawn up by the Paris-based Committee of European Securities Regulators could be very burdensome, costly and even affect market liquidity, traders and investors warned regulators on Wednesday.

“Our members are not convinced that there is a need for this expanded scope,” representatives of the London Investment Banking Association told a public hearing in Paris on Wednesday.

That position won immediate support from users in other big markets, such as Germany, while the European Fund and Asset Management Association warned that more clarity on technical definitions was required before it could estimate how fund management companies in the European Union would be affected.

Officials at CESR acknowledged that trying to harmonise the patchwork of short selling rules in Europe was “complex and difficult”, not least because of the differing legal powers held by different regulators.

But they said that the aim was to use greater transparency as a check against potential disorder in equity markets.

“Aggressive short selling, taken to very high levels . . . still has the ability to create disorder in the market,” said Michael Treip, from Britain’s Financial Services Authority – although he stressed “there is nothing in this proposal seeking to halt such activity [short selling]”.

CESR has drawn up its proposals – which remain out for consultation – in the wake of the market turbulence in the second half of 2008. That prompted many EU member states to impose emergency short selling bans on certain categories of shares, notably in the banking sector.

Under CESR’s plan, outlined in July, hedge funds and other short sellers could be obliged to reveal short positions of as little as 0.1 per cent of a company’s outstanding equity to the regulator of the most liquid market for the stock.

These disclosures would remain private – between the investor and the regulator – but a short position that reached 0.5 per cent or more of the outstanding stock would have to be publicly disclosed.

Such rules would be applied to any shares that were admitted for trading on a regulated market within the European Economic Area or a multilateral trading facility. Market participants would also have to take account of any position that amounted to an “economic exposure” to a particular share – so that exchange-traded and over-the-counter derivatives would also be covered by the proposed rules.

Disclosure calculations and reports would be done on a net basis, with long positions subtracted from the short positions – although CESR officials admitted that more work might be necessary to establish exactly how this would work, for example at fund management level.

But both market participants and CESR officials acknowledged that more empirical evidence of the effects of such a regime would be helpful. The Association of British Insurers, for example, stressed that the organisation was in favour of disclosure but questioned why particular levels had been chosen: “We’re not convinced that enough analysis has been done.”

Meanwhile, the Managed Funds Association, speaking for the hedge fund industry, queried whether other mechanisms for dealing with potential market disorder – such as uptick rules – should also be on the table.

CESR officials, meanwhile, stressed that no final decision had been taken on how to proceed with implementing any changes – for example, by a new EU directive, regulation or within the context of an existing directive. The current consultation closes on September 30.