The 2008 Emergency Regulation of Short Selling Kym Sheehan

Reading Questions 1. According to IOSCO, what are the principles of securities regulation? What is the difference between a principle of securities regulation and a rule of securities regulation? 2.What does the author mean by regulatory objective? Why is it important to have regulatory objectives in mind when devising a system of regulation for an activity such as short selling? 3.All three jurisdictions discussed in the chapter agreed that short selling was a legitimate practice. If short selling is a legitimate market practice, why should short-selling be regulated? Is there any justification for banning short-selling? 4. Prior to 2008, the UK did not regulate short-selling at all (cf Australia and the USA). Why do you think this situation existed? 5. The Australian approach is complicated by the fact that two different regulators were involved with overlapping jurisdiction. What are the benefits and weaknesses of a multi-regulator versus single regulator approach?

Reading Questions 6. The SEC has very different rules on short-selling compared with the UK and Australia. Why do you think this is? 7. Disclosure of short sales was a common regulatory technique deployed in the pre-ban period in Australia and the USA. Why do you think that is? 8. What are the limits of disclosure as a regulatory technique? Identify two different types of disclosure rules mentioned in the chapter and state their regulatory purpose. 8. The FSA noted the optimal level of disclosure of net short positions may be less than full transparency (FSA 2009a, [2.6]). 9. Do you think the circuit breaker mechanism (see Avgouleas 2010) might be a better option to an outright ban? 10. The author comments on transnational regulatory initiatives to regulate short-selling by IOSCO and the Committee of European Securities Regulators (CESR). Why are such transnational approaches to regulating short-selling desirable? Should the role extend beyond standard setting to some form of monitoring of nation states?

Objectives of Securities Regulation IOSCO Principles 2003 Regulation should facilitate capital formation and economic growth No unnecessary barriers to entry to/exit from markets Markets open to widest range of participants ho meet specified entry criteria Regulatory bodies consider the regulatory impact of any policy initiatives All participants should face the same regulatory burden Principles 6.1, 27, 28, 29 and 30.

Objectives of securities regulators Financial systems The performance of the financial system (ASIC) Maintain confidence in the financial system (FSA) protect the national banking and Federal Reserve systems Market integrity Overall efficiency and development of the economy Protecting the financial system can mean taking regulatory actions in the securities markets

Approach: Australia Pre-banTemporary banPost-ban Prohibit short selling Unless seller has a presently existing and unconditional right to vest products in the buyer a 1. Ban all for period 2. Ban all in S&P/ASX 200 Financials Index + 5, but other short sales allowed if comply with s 1020B(2) + (3) no change from (2) in temporary ban Exceptions 1. Odd lot 2. Arbitrage t/as 3. Prior purchasing 4. Prior borrowing 5. ASX Approved SS list None initially then 1. Hedging 2. Exercise ASX ETOs 1. Prior purchasing 2. Exercise of ETO, unobtained financial products and certain bonds and debentures Disclosure on T+1 basis Client tells FSLEE who tells market FSLEE inquiry obligation

Approach: FSA Pre-banTemporary banPost-ban Prohibit short selling Deemed market abuse Failing to make T+1 disclosure of DSP in security subject to rights issue (June 08) Entering into or increasing a net short position in UK Financial company Failure to make T+1 disclosure of DSP (thresholds) Failure to make T+1 disclosure of DSP (0.25%, 0.35%, 0.45%, 0.55% then every 0.1%)

Approach: SEC Pre-banTemporary banPost-ban Prohibit short selling pre-borrow for19 FI then banned for 799 FI Pre-ban situation Exceptions Disclosure on T+1 basis Tagging of order No change C-B-M note No change Weekly report on gross short positions including intraday positions Locate ruleYes but option market maker exception No exceptionsSame as temporary ban Hard close-outT+4 Deemed m-abuse

Issues for move to common approach/1 What is the required relationship between a person and a security that makes the person a short seller (that is, the definition issue)? How certain does the seller need to be that he/she can deliver the securities at settlement (that is, the title issue)?

Issues for move to common approach/2 Short selling is a legitimate practice but... It creates settlement problems that need a regulatory solution It can be a form of market abuse or market manipulation It might create a systemic risk problem

Issues for move to common approach/3 The various regulatory techniques deployed Disclosure-based initiatives 4 dimensions to consider 1. A short position or a short sale 2. Net or gross positions 3. How timely must the disclosure be? 4. How public should the information be? Prohibitions/ restrictions/ exceptions Managing settlement risk

Conclusion Objectives of all three securities regulators refer to the financial system Banned short sales in financial institutions to maintain confidence in banking system: see Exchange Act Release (15 July 2008) re Bear Stearns and rumours Actual regulatory process during temporary ban differed from normal regulatory processes Highly consultative processes shortened Mixed purposes in rules introduced: disclosure to monitor and detect market abuse different from disclosure to inform market Whos going to process all the information gained from different disclosures?