The International Organization of Securities Commissions’ (IOSCO) Technical Committee has published a consultation report entitled Regulation of Short Selling prepared by its Task Force on Short Selling (Task Force), which contains proposed principles designed to help develop a more consistent international approach to the regulation of short selling. The Task Force was established by the Technical Committee in November 2008 in response to concerns regarding the impact short selling was having in the extreme market conditions created by the financial crisis. The Task Force's aims were to work to eliminate gaps between the different regulatory approaches to naked short selling whilst minimising any adverse impact on legitimate activities, such as securities lending and hedging, which are critical to capital formation and reducing market volatility. The report recommends that effective regulation of short selling should be based on the following four principles:
1. Short selling activities should be subject to appropriate controls to reduce or minimise the potential risks that could affect the orderly and efficient functioning and stability of financial markets;
2. Short selling should be subject to a reporting regime that provides timely information to the market or to market authorities;
3. Short selling should be subject to an effective compliance and enforcement system; and
4. Short selling regulation should allow appropriate exceptions for certain types of transactions for efficient market functioning and development.
Kathleen Casey, Chairman of the Technical Committee, said: “IOSCO believes that short selling plays an important role in capital markets for a variety of reasons including more efficient price discovery, mitigating price bubbles, increasing market liquidity, facilitating hedging and other risk management activities. However there is also a general concern that, especially in extreme market conditions such as we have recently experienced, certain types of short selling or the use of short selling in combination with certain abusive strategies may contribute to disorderly markets.” “These principles have been developed with a view to striking a balance between realising the potential benefits of short selling and reducing the adverse impact on financial markets that may arise from abusive short selling.” Martin Wheatley, Chairman of the Task Force on Short Selling, said: “We believe that short selling should operate in a well structured regulatory framework in the interests of maintaining a fair, orderly and efficient market. The objective of such regulation being to reduce the potential destabilising effect that short selling can cause without exerting undue impact on its legitimate benefits in capital formation and volatility reduction.” “While IOSCO encourages a concerted move towards a consistent approach to short selling, it recognises that the case for the regulation of this activity varies from jurisdiction to jurisdiction and depends on a range of domestic factors. These principles will provide guidance to market authorities and assist them in assessing and developing their short selling regulatory framework.”
1. Short selling activities should be subject to appropriate controls to reduce or minimise the potential risks that could affect the orderly and efficient functioning and stability of financial markets;
2. Short selling should be subject to a reporting regime that provides timely information to the market or to market authorities;
3. Short selling should be subject to an effective compliance and enforcement system; and
4. Short selling regulation should allow appropriate exceptions for certain types of transactions for efficient market functioning and development.
Kathleen Casey, Chairman of the Technical Committee, said: “IOSCO believes that short selling plays an important role in capital markets for a variety of reasons including more efficient price discovery, mitigating price bubbles, increasing market liquidity, facilitating hedging and other risk management activities. However there is also a general concern that, especially in extreme market conditions such as we have recently experienced, certain types of short selling or the use of short selling in combination with certain abusive strategies may contribute to disorderly markets.” “These principles have been developed with a view to striking a balance between realising the potential benefits of short selling and reducing the adverse impact on financial markets that may arise from abusive short selling.” Martin Wheatley, Chairman of the Task Force on Short Selling, said: “We believe that short selling should operate in a well structured regulatory framework in the interests of maintaining a fair, orderly and efficient market. The objective of such regulation being to reduce the potential destabilising effect that short selling can cause without exerting undue impact on its legitimate benefits in capital formation and volatility reduction.” “While IOSCO encourages a concerted move towards a consistent approach to short selling, it recognises that the case for the regulation of this activity varies from jurisdiction to jurisdiction and depends on a range of domestic factors. These principles will provide guidance to market authorities and assist them in assessing and developing their short selling regulatory framework.”
RECOMMENDATIONS
The report outlines the minimum that regulators should do in order to support each of the four principles. The First Principle – appropriate controls to reduce or minimise the potential risks that could affect the orderly and efficient functioning and stability of financial markets In order to reduce or minimise the potential risks from short selling, regulators should have an effective discipline for the settlement of short selling transactions. As a minimum requirement this should impose strict settlement (such as compulsory buy-in) of failed trades. The Second Principle - a reporting regime that provides timely information to the market or to market authorities In order to achieve this enhanced level of transparency regarding short selling activity, jurisdictions should consider some form of reporting of short selling information to the market or to market authorities. The Third Principle - an effective compliance and enforcement system This is essential for an effective short selling regulatory regime. The regulators should:
The report outlines the minimum that regulators should do in order to support each of the four principles. The First Principle – appropriate controls to reduce or minimise the potential risks that could affect the orderly and efficient functioning and stability of financial markets In order to reduce or minimise the potential risks from short selling, regulators should have an effective discipline for the settlement of short selling transactions. As a minimum requirement this should impose strict settlement (such as compulsory buy-in) of failed trades. The Second Principle - a reporting regime that provides timely information to the market or to market authorities In order to achieve this enhanced level of transparency regarding short selling activity, jurisdictions should consider some form of reporting of short selling information to the market or to market authorities. The Third Principle - an effective compliance and enforcement system This is essential for an effective short selling regulatory regime. The regulators should:
· monitor and inspect settlement failures regularly;
· consider whether they are able to extend the power to require information from parties suspected of breach, beyond the scope of licensed or registered persons if they lack such power;
· establish a mechanism to analyse the information obtained from the reporting of short positions and/or flagging of short sales to identify potential market abuses and systemic risk; and
· review whether their existing cross-border information sharing arrangements are sufficient to facilitate cross-border investigation.
The Fourth Principle - allow appropriate exceptions for certain types of transactions for efficient market functioning and development It is necessary that there is flexibility in short selling regulation in order to allow market transactions that are desirable for efficient market functioning and development. Therefore regulatory authorities should at a minimum clearly define the exempted activities and the manner in which these exemptions should be reported. The deadline for responses to this consultation paper is 4 May 2009.
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