ESMA submits final report on Short Selling Regulation
05 April 2022 France
Image: AdobeStock/iQoncept
The European Securities and Markets Authority (ESMA) has released its final report on its review of the EU Short Selling Regulation and this report has now been submitted to the European Commission.
The report builds on experience gained during the COVID-19 pandemic relating to the emergency procedures applied by national supervisors and ESMA鈥檚 decision to lower the reporting threshold for net short positions.
It also explored implications of recent trading in meme stocks in US markets where, in ESMA鈥檚 words, large purchases of shares and call options in those meme stocks, combined with high levels of short positions, created the conditions for sharp price increases leading to a 鈥榮hort squeeze鈥�.
ESMA proposes revisions to the rules for relevant competent authorities (RCAs) to apply long-term and short-term short selling breaks. These changes are designed to ensure that the RCA and ESMA have the powers necessary to tackle emergency situations and that clear procedures are in place to guide these actions.
The review process makes amendments to the framework for calculating net short positions and the list of shares for which exemptions should apply to the SSR.
It also proposes changes to the locate rule for assessing stock loan availability and tighter record keeping requirements to monitor uncovered short sales.
Reflecting on the high market volatility that accompanied meme stock trading during 2021, ESMA proposes the introduction of a centralised system, led by ESMA, for publication and disclosure of net short positions to the public.
This will potentially include an EU-wide obligation for RCAs to publish aggregated net short positions per issuer, on a periodic basis, for all individual positions that meet or exceed the notification and publication thresholds.
To inform the review process, ESMA published a consultation process in September 2021 that called for industry feedback relating to the major themes outlined above.
In preparing its consultation paper, ESMA conducted an impact assessment of the long-term bans adopted under Article 20 of the SSR during the first wave of the pandemic in 2020. This impact study evaluated the effect of the bans on market quality, analysing liquidity, returns and volatility indicators, along with the risk of displacement effects between countries.
The analysis was conducted at European level, including all EEA30 countries and the UK.
Among the high-level findings in its impact analysis, ESMA concluded that the short-selling bans applied during the crisis were associated with a deterioration in market liquidity, as measured by bid-ask spreads and the Amihud illiquidity indicator. This negative impact on liquidity was more significant for large cap stocks, for 鈥渉ighly fragmented stocks鈥�, and for shares with listed derivatives.
ESMA found that shares in countries that applied short selling bans exhibited a lower level of volatility, typically 6-10 per cent lower, during the period of the ban. However, it says that the bans did not significantly harm market prices during this period.
Overall, ESMA indicates that there were no clear displacement effects between countries as a result of short-selling bans.
In concluding, ESMA states that the long-term short-selling bans in Europe during 2020 had 鈥渕ixed effects鈥� 鈥� resulting in a deterioration of market liquidity on one hand, but reducing the volatility of the relevant shares on the other.
It therefore finds that the current SSR framework, accompanied by selective operational improvements, will support the ability of relevant competent authorities to address concerns around financial stability.
In summarising the feedback that it received during the consultation process, ESMA indicates that 鈥渢he majority of respondents did not agree with the conclusions of ESMA鈥檚 analysis. Those respondents were very critical and provided several arguments in favour of short selling activities, including references to analyses that reached the conclusion that short selling is not detrimental.鈥�
Those supporting ESMA鈥檚 assessment said that although short selling plays an important role in price discovery in normal market conditions, it can potentially contribute to unnecessary downward pressure on share prices in conditions of market stress.
The matter was discussed further within the Securities Markets Stakeholder鈥檚 Group (SMSG), which offered divergent views on whether short selling bans during the pandemic were counterproductive or useful.
Some SMSG participants indicated that short selling is hugely important for price discovery, liquidity provision and market efficiency in adverse circumstances and highly volatile markets. For others, short selling bans offer important protection to issuers and investors.
In its recommendations, SMSG proposed that ESMA should be required to conduct an ex-post analysis of any future short selling bans, with a remit to inform market participants and to increase knowledge about the impact of such bans.
The report builds on experience gained during the COVID-19 pandemic relating to the emergency procedures applied by national supervisors and ESMA鈥檚 decision to lower the reporting threshold for net short positions.
It also explored implications of recent trading in meme stocks in US markets where, in ESMA鈥檚 words, large purchases of shares and call options in those meme stocks, combined with high levels of short positions, created the conditions for sharp price increases leading to a 鈥榮hort squeeze鈥�.
ESMA proposes revisions to the rules for relevant competent authorities (RCAs) to apply long-term and short-term short selling breaks. These changes are designed to ensure that the RCA and ESMA have the powers necessary to tackle emergency situations and that clear procedures are in place to guide these actions.
The review process makes amendments to the framework for calculating net short positions and the list of shares for which exemptions should apply to the SSR.
It also proposes changes to the locate rule for assessing stock loan availability and tighter record keeping requirements to monitor uncovered short sales.
Reflecting on the high market volatility that accompanied meme stock trading during 2021, ESMA proposes the introduction of a centralised system, led by ESMA, for publication and disclosure of net short positions to the public.
This will potentially include an EU-wide obligation for RCAs to publish aggregated net short positions per issuer, on a periodic basis, for all individual positions that meet or exceed the notification and publication thresholds.
To inform the review process, ESMA published a consultation process in September 2021 that called for industry feedback relating to the major themes outlined above.
In preparing its consultation paper, ESMA conducted an impact assessment of the long-term bans adopted under Article 20 of the SSR during the first wave of the pandemic in 2020. This impact study evaluated the effect of the bans on market quality, analysing liquidity, returns and volatility indicators, along with the risk of displacement effects between countries.
The analysis was conducted at European level, including all EEA30 countries and the UK.
Among the high-level findings in its impact analysis, ESMA concluded that the short-selling bans applied during the crisis were associated with a deterioration in market liquidity, as measured by bid-ask spreads and the Amihud illiquidity indicator. This negative impact on liquidity was more significant for large cap stocks, for 鈥渉ighly fragmented stocks鈥�, and for shares with listed derivatives.
ESMA found that shares in countries that applied short selling bans exhibited a lower level of volatility, typically 6-10 per cent lower, during the period of the ban. However, it says that the bans did not significantly harm market prices during this period.
Overall, ESMA indicates that there were no clear displacement effects between countries as a result of short-selling bans.
In concluding, ESMA states that the long-term short-selling bans in Europe during 2020 had 鈥渕ixed effects鈥� 鈥� resulting in a deterioration of market liquidity on one hand, but reducing the volatility of the relevant shares on the other.
It therefore finds that the current SSR framework, accompanied by selective operational improvements, will support the ability of relevant competent authorities to address concerns around financial stability.
In summarising the feedback that it received during the consultation process, ESMA indicates that 鈥渢he majority of respondents did not agree with the conclusions of ESMA鈥檚 analysis. Those respondents were very critical and provided several arguments in favour of short selling activities, including references to analyses that reached the conclusion that short selling is not detrimental.鈥�
Those supporting ESMA鈥檚 assessment said that although short selling plays an important role in price discovery in normal market conditions, it can potentially contribute to unnecessary downward pressure on share prices in conditions of market stress.
The matter was discussed further within the Securities Markets Stakeholder鈥檚 Group (SMSG), which offered divergent views on whether short selling bans during the pandemic were counterproductive or useful.
Some SMSG participants indicated that short selling is hugely important for price discovery, liquidity provision and market efficiency in adverse circumstances and highly volatile markets. For others, short selling bans offer important protection to issuers and investors.
In its recommendations, SMSG proposed that ESMA should be required to conduct an ex-post analysis of any future short selling bans, with a remit to inform market participants and to increase knowledge about the impact of such bans.
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