October 30, 2012
The European Union has adopted a new regulation on short selling and certain aspects of credit default swaps (Regulation (EU) 236/2012) (the “Regulation“). The Regulation takes effect from November 1, 2012. The Regulation has been supplemented by the Implementing Regulation (EU) 827/2012 of June 29, 2012 (the “Implementing Regulation“) and three delegated regulations:
In addition, European Securities and Markets Authority (“ESMA“) published a Q&A on September 13, 2012 relating to the Regulation, which was updated on October 10, 2012 (the “ESMA Q&A“). The Regulation, together with the Implementing Regulation, the Delegated Regulations and the ESMA Q&A, create an EU-wide framework for the coordinated regulation of short selling. This framework requires public disclosure of certain short positions in relation to covered financial instruments and restricts uncovered short positions for these same financial instruments. This client alert highlights several key features of the Regulation and the EU’s new short selling regulatory framework.
The Regulation applies to financial instruments traded on an EU-regulated market or multilateral trading facility. The Regulation can also apply to these instruments when they are traded outside an EU-regulated market or multilateral trading facility. The ESMA Q&A states that the location of a transaction, and the domicile or location of the parties to the transaction, are irrelevant when assessing whether or not the Regulation applies.
The Regulation also sets outs rules relating to short positions in sovereign debt and sovereign credit default swaps (“CDS“) issued by (i) the EU, (ii) any EU member state (including any government department, agency, or a special purpose vehicle of an EU member state), (iii) in the case of a federal EU member state, a member of the federation, (iv) a special purpose vehicle for several EU member states, (v) an international financial institution established by two or more EU member states for the purpose of providing assistance to EU members states experiencing severe financing problems, or (vi) the European Investment Bank.
Transparency Obligations for Shares
The Regulation sets out confidential notification and public disclosure requirements for significant net short positions in shares.
Confidential Notification Requirements
A net short position in relation to the issued share capital of a company that has shares admitted to trading on a trading venue must be notified to the competent authority of the EU member state in which the trading venue is located when:
Public Disclosure Requirements
A net short position in relation to the issued share capital of a company that has shares admitted to trading on a trading venue must be publicly disclosed when:
Calculating Net Short Position for Shares
A net short position in relation to the issued share capital of a company is determined by calculating the difference between the long and short positions of a person in the issued share capital of a company using a delta adjusted model. For the purpose of determining a net short or long position, the calculation must take into account any position held by the relevant person, including through or by way of any index, basket of securities or any interest in any exchange-traded fund or similar entity. The calculation must also take into account:
The calculation should not take into account:
With respect to the calculation of the net short position for funds and other similar structures, the net short positions of the funds and portfolios under management by the same management entity for which the same investment strategy is pursued in relation to a particular issuer must be aggregated. As part of this aggregation, any positions of the funds and portfolios where management has been delegated to the management entity by a third party should be included. However, the positions of the funds and portfolios where management has been delegated by the management entity to a third party should be excluded.
Transparency Obligations for Sovereign Debt
Net short positions relating to sovereign debt are required to be disclosed on a confidential basis to the relevant competent authority when the amount of the positions exceeds certain thresholds published by ESMA. These thresholds are calculated as percentages of the monetary amount of the position as follows:
Transparency Obligations for Sovereign CDS
If a competent authority in an EU member state suspends restrictions on sovereign CDS (see “Restrictions on Uncovered (naked) Short Sales — Sovereign CDS” below), an uncovered position on a sovereign credit default swap must be notified to the relevant competent authority where that position reaches or falls below the relevant notification thresholds for the sovereign issuer in respect of sovereign debt.
Calculation of Net Short Position for Sovereign Debt
A net short position in relation to the issued sovereign debt is determined by calculating the difference between the long and short positions of a person in the same sovereign debt using a delta adjusted model. Long positions in sovereign debt which are highly correlated with the pricing of the sovereign debt must be included as part of a person’s overall long position. The calculation of the net short position for sovereign debt must include CDS which relate to the sovereign issuer. For assets with a liquid market price, a high correlation between the pricing of a debt instrument of another sovereign issuer and the pricing of the debt of the given sovereign issuer must be measured on a historical basis. Where there is no liquid market, an appropriate proxy should be used. In addition, the same principles applicable to the calculation of the net short position for shares also generally apply to the calculation of the net short position for sovereign debt.
Timing of Notifications and Disclosures
The notifications or disclosures required under the Regulation must be made by 3:30 pm local time on the following trading day. Local time is determined by reference to the time in the EU member state of the relevant competent authority to which the relevant position must be notified. The first disclosures under the Regulation must be made by 3:30 pm local time on November 2, 2012.
Reports provided in compliance with the Regulation are required to be in English or the language of the relevant competent authority in an EU member state. Confidential notifications to a competent authority of net short positions in shares or sovereign debt must include certain specified information and such information must be submitted on a particular form. Likewise, public disclosures of net short positions in shares must also contain certain specified information. The Implementing Regulation specifies how competent authorities should disclose this information to the public. Holders of significant net short positions will also be required to keep records of the gross positions that make a significant net short position for a period of five years.
Competent authorities will also be required to provide ESMA with certain information relating to net short positions on a quarterly basis and the information requested by ESMA from time to time. ESMA has published a document containing links to the websites of the competent authorities of various EU member states where the information on the process and forms for notifying the competent authority in each EU member state is made available.
Restrictions on Uncovered (naked) Short Sales
Shares and Sovereign Debt
The Regulation also prohibits short selling of shares and sovereign debt admitted to trading unless one of the following conditions is fulfilled:
In respect of futures and swaps, options and repo agreements, the contract must be in respect of at least the number of shares sold short, entered into no later than the time of the short sale and must specify a delivery or expiration date that ensures that the short sale can be effected when due.
The Regulation prohibits uncovered sovereign CDS, which is defined as a sovereign credit default swap which does not serve to hedge against:
A competent authority may temporarily suspend the prohibition on uncovered sovereign CDS where it finds on objective grounds that its sovereign debt market is not functioning properly and that such restrictions might have a negative impact on the sovereign credit default swap market.
Central counterparties in EU member states should adopt procedures which comply with the following requirements:
A central counterparty must ensure that a person who sells shares and fails to deliver the shares for settlement by the date on which settlement is due must make daily payments for each day that the failure continues. These penalties should be sufficiently high to act as a deterrent to failing to settle.
Participants in EU financial markets who trade shares of companies listed in the EU, EU sovereign debt or CDS in relation to the foregoing (including market participants in the U.S.) should:
 The Implementing Regulation sets out implementing technical standards for the public disclosure of net position in shares, the format of the information provided to ESMA regarding 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 the Regulation.
 Delegated Regulation 826/2012 supplements the Regulation by providing regulatory technical standards on notification and disclosure requirements of net short positions, details of information to be provided to ESMA in relation to net short positions and the method for calculating turnover to determine exempted shares.
 Delegated Regulation 918/2012 supplements the Regulation with regard to certain 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.
 Delegated Regulation 919/2012 supplements the Regulation by providing technical standards for calculating the fall in value for liquid shares and other financial instruments.
 The ESMA Q&A and other guidance from ESMA are not legally binding and are not EU law. Nevertheless, ESMA guidance is viewed as significant by competent authorities and compliance with ESMA’s guidance may be viewed by competent authorities as an indication of compliance with the Regulation.
 The Regulation defines a multilateral trading facility as a multilateral system, operated by an investment firm or a market operator, which brings together multiple third‑party buying and selling interests in financial instruments — in the system and in accordance with non‑discretionary rules — in a way that results in a contract.
 See ESMA Q&A Question 1a.
 See ESMA Q&A Question 1d.
 See Table 1 of Annex I of Delegated Regulation 826/2012.
 See Annex II of Delegated Regulation 826/2012.
 See Table 2 of Annex I of Delegated Regulation 826/2012.
 See Article (2), Implementing Regulation.
 See Article 11(2) of the Regulation and Articles 4 and 5 of Delegated Regulation 826/2012.
 ESMA’s list of the websites of the competent authorities of various EU member states with authority for administering the Regulation is available at http://www.esma.europa.eu/system/files/2012-680.pdf.
Gibson, Dunn & Crutcher lawyers are available to assist you with any questions you may have relating to the subject matter of this update. Please contact the Gibson Dunn lawyer with whom you usually work, or any of the following lawyers in the firm’s London office:
Jeffery Roberts (+44 20 7071 4291, firstname.lastname@example.org)
Edward A. Tran (+44 20 7071 4228, email@example.com)
© 2012 Gibson, Dunn & Crutcher LLP
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