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This publication is available at https://www.gov.uk/government/publications/draft-short-selling-amendment-eu-exit-regulations-2018/short-selling-amendment-eu-exit-regulations-2018-explanatory-information
The European Union (Withdrawal) Act 2018 (EUWA) repeals the European Communities Act 1972 on the day the UK leaves the EU and converts into UK domestic law the existing body of directly applicable EU law. The purpose of the EUWA is to provide a functioning statute book on the day we leave the EU.
The EUWA also gives ministers powers to make statutory instruments (SIs) to prevent, remedy or mitigate any failure of EU law to operate effectively, or any other deficiency in retained EU law. We refer to these contingency preparations for financial services legislation as ‘onshoring’.
HM Treasury is using these powers to ensure that the UK continues to have a functioning financial services regulatory regime in any scenario.
This SI is part of the wider work the government is undertaking to prepare for the UK’s withdrawal from the EU. It is not intended to make policy changes, other than to reflect the UK’s new position outside the EU, and to smooth the transition. The changes made in this SI would not take effect on 29 March 2019 if, as expected, we enter an implementation period.
The attached draft SI is intended to provide Parliament and stakeholders with further details on our approach to onshoring financial services legislation. The draft instrument is still in development. The drafting approach, and other technical aspects of the proposal, may change before the final instrument is laid before Parliament.
3. Policy background and purpose of the SI
3.1 What does the underlying EU regulation and UK law do?
Short selling is the practice of selling a security that is borrowed or not owned by the seller with the intention of buying it back later at a lower price to make a profit.
In response to the financial crisis, where a number of EU countries, including the UK, acted to suspend or ban short selling, the EU introduced the Short Selling Regulation (SSR). This ensures greater coordination and consistency between member states where measures have to be taken to restrict short selling in exceptional circumstances such as threats to financial stability and market confidence. The SSR also increases transparency of short positions held by investors in certain EU securities through notification requirements.
The EU SSR applies to financial instruments admitted to trading or traded on an EEA trading venue (unless they are primarily traded on a third country venue). The regulation also applies to debt instruments issued by EU sovereign issuers and related credit default swaps. The SSR requires holders of significant net short positions in shares or sovereign debt to make notifications of their positions to their national competent authority (NCA) once certain thresholds have been breached. It outlines restrictions on investors entering into uncovered short positions in shares or sovereign debt and contains buy-in procedures and late settlement requirements to ensure settlement discipline. The SSR also enables NCAs to tackle the downward spiral in the prices of shares, notably financial institutions, which could otherwise threaten their viability and create systemic risks during times of market stress.
3.2 Correcting deficiencies in retained EU law relating to short selling – Part 3 of SI
This SI will make amendments to retained EU law related to the SSR to ensure that it continues to operate effectively in the UK once the UK has left the EU.
The changes for firms with shares admitted to trading on a UK venue are anticipated to be minimal. The current mechanics for firms submitting relevant notifications for UK instruments to the Financial Conduct Authority (FCA) will be retained and instruments admitted to trading on UK venues will continue to have the same restrictions applied to them.
Changes introduced by the SI include:
Amending the scope of the regulation to relate to instruments admitted to trading on UK venues and UK sovereign debt only
UK SSR will not capture instruments admitted to trading or traded on an EEA trading venue.
Deleting provisions to facilitate cooperation and coordination across the Union
The EU SSR includes measures to ensure a consistent approach to short selling in the event of a significant fall in the price of a share or in response to a threat to market confidence or financial stability in the Union. Under the EU SSR member states are required to notify other NCAs ahead of taking action to restrict short selling. Other NCAs will then determine whether to apply corresponding restrictions on their venues. As the UK will no longer be part of the EU these provisions are deleted. European Securities and Markets Authority’s (ESMA) intervention powers in exceptional circumstances have also been removed. The FCA will retain its powers to restrict short selling in the event of a significant fall in the price of a share or in response to a threat to UK financial stability or market confidence.
However, this will not preclude UK supervisors from sharing information with EU authorities where necessary, as the existing domestic framework for cooperation and information sharing with countries outside the UK already allows for this on a discretionary basis.
Exemption where the principal trading venue is in a third country
EU SSR provides certain exemptions from the reporting requirements, the buy-in regime and restrictions on uncovered short selling for shares which are principally traded in a third country. Every two years each NCA will determine whether shares for which they are the relevant NCA are principally traded in a third country and are therefore eligible for this exemption. The ESMA collates and publishes a list of these exempt shares.
Under the UK SSR the FCA will take on responsibility for collating and publishing the list of shares principally traded in a third country. This will include shares which have their principal trading venue outside of the UK, including those in the EU. To ensure continuity for firms the SI allows the FCA to recognise ESMA’s existing list for 2 years following exit day.
Exemptions for market makers and authorised primary dealers
Under the EU SSR, there are certain exemptions for market-making activities and primary market operations. This means that certain market makers (individuals or companies that provide liquidity to the market by selling and buying securities) do not have to disclose net short positions or comply with the restrictions on uncovered short selling. To benefit from the exemption, a market maker must notify the NCA of its home member state that it intends to make use of the exemption no less than 30 days before it first intends to use the exemption. The SI includes a provision to ensure that notifications made to the FCA ahead of exit will remain valid. To benefit from the exemption European market makers will be required to join a UK trading venue and submit a notification to the FCA at least 30 days ahead of the UK’s exit, to enable a smooth transition, in a scenario where the UK was not entering an implementation period. This is consistent with how the UK treats other third countries.
Scope of powers to address threats to financial stability or market confidence
The EU SSR provides NCAs with powers to restrict short selling or require disclosure of net short positions in response to a serious threat to financial stability or market confidence in the Union. At present, the UK can impose a restriction on an instrument which is trading on a UK venue but primarily traded in a third country outside of the Union. It can also take action on instruments for which it is the most liquid market in Europe or where the instrument was first admitted to trading in the UK. However, if the UK wishes to take action on an instrument which has its most liquid market elsewhere in the Union or was first admitted to trading on an EU venue it will need to seek the consent of the relevant European NCA.
The SI deletes this provision, treating these instruments in line with other third country instruments. This would allow the UK to take action on any instrument admitted to trading on a UK venue, not just those for which it is the most liquid market. The UK will only consider threats to UK market confidence and financial stability ahead of using these powers.
3.3 Correcting deficiencies in the Commission Delegated Regulation No 918/2012– Part 4 of SI
Sovereign credit default swaps (CDS) can be used to insure against the risk of sovereign default or a change in a sovereign’s creditworthiness. Under the EU SSR, sovereign CDS positions can only be entered into for legitimate hedging purposes. To qualify, the assets must be correlated to the value of the sovereign debt and be obligations to public or private sector entities in the same member state or another member state where high correlation could be demonstrated.
The SI will allow market participants to use UK sovereign CDS to hedge correlated assets or liabilities located anywhere in the world, rather than just in the EU. This will ensure UK firms can continue to use UK sovereign CDS to hedge correlated assets or liabilities issued by issuers located outside the UK.
3.4 Relevant rulebook and binding technical standard changes
The FCA will be updating its rulebook and relevant binding technical standards to reflect the changes introduced through this SI, and to address any deficiencies as a result of the UK leaving the EU. The FCA has confirmed its intention to consult on these changes in the autumn.
This SI will affect investment firms and investment managers involved in the short selling of UK listed shares or sovereign debt, which are already regulated in the UK under the EU SSR. As already noted, the intention of this SI is not to make policy changes, other than to reflect the UK’s new position outside the EU, and to smooth the transition to this position. HM Treasury has engaged with industry bodies where possible to ensure awareness of these changes.
This SI does not include provisions that will be necessary to ensure Gibraltarian financial services firms’ continued access to UK markets in line with the UK government’s statement in March 2018, and other provisions dealing with Gibraltar more generally. Provisions covering Gibraltar will be included in future SIs.
4. Next steps
HM Treasury plans to lay this instrument before Parliament in the autumn.
5. Further information
If you have queries regarding this instrument, email FSlegislationEUWA@hmtreasury.gov.uk.