1. 1 Short selling and clearing and settlement in Europe: relations and implications Daniela Russo and Simonetta Rosati

2. 2 Reading Questions 1. What are the relations between short selling and settlement fails 2. What are the main factors determining settlement fails? 3. What are the consequences of fails? 4. When does a short sale transaction give rise to a settlement risk? 5. What are the measures and rules in place to address short selling and settlement fails? 6. In particular, what are the measures to prevent fails? 7. And, what are the measures to discourage fails? 8. And what are the measures to mitigate effects of fails? 9. What are the relations between short-selling market discipline and settlement discipline? 10. How do short sales have any impact on effectiveness of market discipline?

3. 3 Short selling and settlement fails Shirt selling may result in a non-delivery of traded assets on the settlement date (i.e. settlement fails). This could, in turn, has the potential to degenerate into systemic risks, which ultimately may undermine confidence in the use of the relevant market infrastructure and of the related financial market segment (e.g. repo market).

4. 4 Main factors determining fails Operational risks (e.g. breakdown suffered by Bank of New York un 1985) Liquidity problemsn of major investors Lack of incentives to avoid fails

5. 5 Main consequences of fails Credit risks for major market players (in case they have paid for the delivery of assets that will not be delivered) Liquidity risk of major market players (due to the need to buy the non delivered assets in the relevant market) Systemic effects that will contribute to increase the fails and prolong their duration

6. 6 Short sale and settlement risk Naked short selling is considered more prone to settlement risk because of the limited time available to find the assets needed for the settlement Additional settlement risk can be created by strategic fails (i.e. fails provoked by the unwillingness to borrow assets, when their costs is more costly than the cost of the fail)

7. Measures to prevent fails Use of automated procedures for transmission and matching of settlement instructions Use of Central Counterparties More information/transparency on the transactions that are likely to fail Liquidity optinmisation measures 7

8. 8 Measures to discourage fails Increase the cost of fails Forbid short sales

9. 9 Measures to mitigate fails Forced buy-in procedures (i.e. procedures where the SSS buys the non-delivered securities on behalf of the failing party) Forced sell-out procedures (i.e. procedures where the collateral of the failing part is sold to complete the transaction in favour of the selling party)

10. 10 Relations between short selling and market discipline Approaches largely complementary ( having an effective discipline for settlement of short selling transactions is the first pillar for an effective short selling regulatory regime (IOSCO, 2009)) This raises questions of co-ordination between relevant authorities

11. 11 Conclusion This article provided insights into: Relations between short selling and settlement fails Causes and effects of settlement fails Market discipline on settlement fails and short selling The effects of market discipline for settlement fails on short sale regulation