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Q&A on the prohibition of uncovered short sales in shares and in sovereign debt

Regulation (EU) No 236/2012 on short selling and certain aspects of credit default swaps

Date: 07.11.2012 06:00 PM, updated on 10.08.2015

Frequently asked questions on the ban on uncovered short sales in shares and in sovereign debt pursuant to Articles 12 and 13 of Regulation (EU) No 236/2012 on short selling and certain aspects of credit default swaps (EU Short Selling Regulation)

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These FAQs are regularly updated by BaFin. Please direct any queries you may have exclusively to +49 (0)228/4108-4004 or by e-mail to short-selling@bafin.de

Legal basis

1. Are there any additional relevant provisions apart from the EU Short Selling Regulation?

Yes, regulation of short selling in Europe is established not only in Regulation (EU) No 236/2012 on short selling and certain aspects of credit default swaps (EU Short Selling Regulation) but also in four implementing regulations. These four implementing regulations clarify the provisions of the EU Short Selling Regulation to ensure its consistent application and facilitate its enforcement. These are: Commission Delegated Regulation (EU) No 826/2012 laying down regulatory technical standards concerning, among other things, notification and disclosure requirements for net short positions; Commission Implementing Regulation (EU) No 827/2012 concerning implementing technical standards on, among other things, the means for public disclosure of net short positions in shares and the agreements for covering short sales in shares or sovereign debt instruments; Commission Delegated Regulation (EU) No 918/2012 outlining, among other things, definitions, the calculation of net short positions and notification thresholds; and Commission Delegated Regulation (EU) No 919/2012 with regard to regulatory technical standards for the method of calculation of the fall in value for liquid shares and other financial instruments.

1a. Are there any additional relevant provisions?

Yes, the European Securities and Markets Authority (ESMA) has published questions and answers (ESMA Q&As) with regard to the EU Short Selling Regulation which it will update and supplement as necessary.

In addition to these FAQs on the ban on uncovered short sales in shares and sovereign debt, there are further FAQs regarding the notification and publication requirements.

Scope of application

2. As of when do the prohibiting provisions pursuant to Articles 12 and 13 of the EU Short Selling Regulation apply?

The bans on uncovered short sales in shares and in sovereign debt pursuant to Articles 12 and 13 of the EU Short Selling Regulation have been in effect since 1 November 2012.

3. To which financial instruments do the prohibiting provisions pursuant to Article 12 and Article 13 of the EU Short Selling Regulation apply?

a.) Pursuant to Article 12 of the EU Short Selling Regulation, the ban on uncovered short sales in shares applies to all shares admitted to trading on a trading venue within the Union. The regulated market and multilateral trading systems (MTF) are deemed trading venues within the meaning of the EU Short Selling Regulation. An exemption pursuant to Article 16(1) of the EU Short Selling Regulation exists for those shares which are admitted to trading on a trading venue in the Union where the principal venue for trading is located in a third country. A list of exempted shares that are not subject to regulation is published by ESMA.

b.) Pursuant to Article 13 of the EU Short Selling Regulation, the ban on uncovered short sales in sovereign debt applies to debt issued by sovereign issuers. Sovereign issuers are (i) the Union; (ii) a Member State, including a government department, an agency, or a special purpose vehicle of the Member State; (iii) in the case of a federal Member State, a member of the federation; (iv) a special purpose vehicle for several Member States; (v) an international financial institution established by two or more Member States which has the purpose of mobilising funding and provide financial assistance to the benefit of its members that are experiencing or threatened by severe financing problems; and (vi) the European Investment Bank (see also Article 2(1)(d) and (f) of the EU Short Selling Regulation). On a quarterly basis, ESMA publishes a list of the thresholds applying to sovereign debt. This list can be used as a point of reference for the categorisation of sovereign issuers.

3a. For which financial instruments is BaFin the competent authority?

The competent authority is defined in Article 2(1)(j) of the EU Short Selling Regulation.

In the case of sovereign debt of a Member State or one of the members of its federation, the authority of the respective Member State is the competent authority. In the case of sovereign debt issued by the Federal Republic of Germany or the German federal states, BaFin is the competent authority.

For shares, the competent authority is found in Article 2(1)(j)(v) of the EU Short Selling Regulation in conjunction with Article 2(7) of Regulation (EC) No 1287/2006 and in Article 2(1)(j)(vi) of the EU Short Selling Regulation. The competent authority in Germany is BaFin.

4. Are foreign currency bonds of EU Member States whose legal currency is the euro also covered?

Yes, the prohibiting provision of Article 13 of the EU Short Selling Regulation also covers sovereign debt which has not been issued in euros. The sole criterion is that the issuer is a sovereign issuer within the meaning of Article 2(1)(d) of the EU Short Selling Regulation.

Example:

A government bond issued by the UK in pound sterling and bonds of the Free State of Saxony in US dollars in both cases are subject to the provisions of Article 13 of the EU Short Selling Regulation.

5. Is trading on the regulated unofficial market (Freiverkehr) or another multilateral trading facility (MTF) also covered?

Yes, it does not matter where the specific transaction is executed. Just like the geographical place of conclusion of an uncovered short sale, the trading venue on which the short sale is performed is without relevance. As long as the traded financial instruments fall within the scope of Articles 12 and 13 of the EU Short Selling Regulation (see Question 3), trading in such financial instruments is covered regardless of whether it takes place on the regulated unofficial market (Freiverkehr) or other multilateral trading systems (MTF). Where an uncovered short sale of shares or sovereign debt covered by Articles 12 and 13 of the EU Short Selling Regulation is effected off-exchange (OTC), this also falls within the scope of the prohibiting provision.

6. Does the ban also concern intraday short positions?

Yes, intraday uncovered short sales in shares and in sovereign debt are covered by the ban on short selling of Articles 12 and 13 of the EU Short Selling Regulation. Coverage must exist at the latest at the moment when the short sale takes place. The intraday exemption provided under German legislation up to 31 October 2012 for shares no longer exists as per 1 November 2012.

7. Does the ban also refer to derivatives?

No, the ban on short selling pursuant to Articles 12 and 13 of the EU Short Selling Regulation refers only to shares and sovereign debt, but not to derivatives. In this regard it does not matter whether on an economic view the respective derivative is to be deemed equivalent to a short position.

Example:

If a trading participant sells a future, this does not constitute a violation of Articles 12 and 13 of the EU Short Selling Regulation.

8. Do short positions in shares or in sovereign debt arising from trading in options fall under the ban?

No, for example the sale of a call option (short call) does not yet result in a short position in shares or in sovereign debt. A short position arises only when the call option is exercised, since it is only then that a delivery obligation arises with the option writer who then has to settle the same. However, this short position is not relevant for the ban because it arises from exercise of the option and not from a sale of the share or the sovereign debt.

9. Does the ban also apply to uncovered short sales performed abroad and/or by foreign nationals?

Yes, it does not matter whether the shares or government debt covered by the prohibiting provisions of Articles 12 and 13 of the EU Short Selling Regulation are traded in Germany or abroad. Neither is the nationality of the trading participants or their domicile of any relevance in this regard. The only thing that is decisive is that the traded financial instruments fall within the scope of Articles 12 and 13 of the EU Short Selling Regulation (see Question 3).

Example:

If a trading participant domiciled in China short-sells on a US stock exchange a German share that falls under the EU Short Selling Regulation, this constitutes a violation of Article 12(1) of the EU Short Selling Regulation.

Coverage of short sales

10. When does a coverage transaction have to be concluded and does the unconditionally enforceable claim also have to be due on conclusion?

A coverage transaction must be concluded prior to or at the same time as the short sale. For assessing the question of whether an unconditionally enforceable claim exists, what is decisive is whether under the contractual agreement the shares or sovereign debt are transferred in such timely manner that the creditor (=short seller) is put in a position to settle the obligation arising from the short sale in due time.

10a. Can a short sale be covered by shares of the same issuer with a different WKN/ISIN?

No, a short sale can only be covered by shares of the same class under capital market law. This applies to all forms of coverage contemplated by Article 12(1) and, where applicable, Article 12(2) of the EU Short Selling Regulation in conjunction with the different types of agreement covered by Article 5(1) or Article 6 of Regulation (EU) No 827/2012.

Whether shares belong to the same class under capital market law or not depends on whether they are structured identically. Only shares with identical ISINs/WKNs belong to the same class under capital market law.

Notably, this implies that derivatives used to cover a short sale must relate to shares of the same class under capital market law.

Example:

A trading participant sells short existing shares of issuer A. The sale is not covered in any other way by existing shares of issuer A. The trading participant does hold new shares of issuer A, however these carry a different dividend entitlement and therefore have a different ISIN. These new shares cannot be used to cover the short sale of the existing shares.

10b. Must coverage of a short sale be held until settlement of the short sale or may it be discontinued without substitute after the short sale?

Coverage of a short sale within the meaning of Article 12 and Article 13 of the EU Short Selling Regulation must, as a matter of principle, exist from entry into the sale agreement up until settlement of the short sale. During this period, coverage may, however, be substituted any number of times. If, after entering into a short sale agreement, a person selling short a security or sovereign debt does not uphold coverage without substituting it with another suitable form of coverage, this person is violating Article 12(1) and Article 13(1) respectively of the EU Short Selling Regulation; as is any person who does not hold suitable coverage when entering into a short sale.

Example:

On day 1, a trading participant sells short a share that falls under the EU Short Selling Regulation, having previously purchased as coverage a suitable forward position with physical settlement and corresponding maturity. No other financial instruments are available to cover the sale. On day 2, the trading participant closes out the forward position, so that delivery from this forward agreement can no longer be used to cover the short sale. The trading participant does not enter into any trades in other financial instruments which may be suitable for coverage. Given that coverage was discontinued, this is an uncovered short sale and thus constitutes a violation of Article 12 of the EU Short Selling Regulation.

11. Can a short sale be covered by a securities lending transaction or by a securities repurchase transaction (repo)?

Yes, a short sale may be covered by a securities lending transaction or by a securities repurchase transaction (repo) if the securities under the agreement have already been delivered to the borrower/short seller (Article 12(1)(a) of the EU Short Selling Regulation) or if an agreement to borrow or an absolutely enforceable claim to transfer of ownership exists (Article 12(1)(b) of the EU Short Selling Regulation). The coverage must be present no later than when the short sale is entered into.

12. Can a short sale be covered by a call option?

Yes, call options issued with certain terms may cover a short sale if they can be qualified as an absolutely enforceable claim within the meaning of Article 12(1)(b) of the EU Short Selling Regulation (for more specific information see Questions 12a. and 12b.).

12a. What must be taken into consideration when covering a short sale with a European call option?

A short sale may be covered by a European call option allowing for physical settlement exercisable exclusively at the end of the term only if the exercise enables the underlying to be transferred in such timely manner that the obligation under the short sale can thereby be settled in due time.

Example:

If a trading participant sells short a share or sovereign debt covered by the European regulation on short selling, having previously purchased as coverage a European call option whose term ends only after the settlement date under the short sale, this is an uncovered short sale and thus constitutes a violation of the EU Short Selling Regulation.

12b. What must be taken into consideration when covering a short sale with an American call option?

A short sale may only be covered by a derivative counter-position in the form of an American call option with physical settlement if it is exercised in time for the underlying to be transferred in such timely manner that the obligation under the short sale can thereby be settled in due time (see also Question 10b.).

Example:

If a trading participant sells short a share or sovereign debt that falls under the EU Short Selling Regulation, having previously purchased as coverage an American call option, and does not exercise the latter in such timely manner that the option can be delivered in due time for the settlement date under the short sale, this is an uncovered short sale and thus constitutes a violation of the EU Short Selling Regulation.

13. Can a short sale be covered by forward transactions or swaps?

A short sale may be covered by a derivative counter-position in the form of a futures long position or swap long position only if the delivery date for the underlying was agreed in such a way that the obligation under the short sale can be settled in due time. Such coverage requires that physical settlement has been agreed. Agreement of cash settlement is not sufficient. Coverage by a forward transaction or swaps must be present no later than when the short sale is entered into.

14. To what extent are shares which are not yet issued affected by the ban on short selling of Article 12 of the EU Short Selling Regulation?

The prerequisite for application of Article 12(1) of the EU Short Selling Regulation is that the share is admitted to trading on a trading venue within the meaning of the EU Short Selling Regulation. That means that, e.g., transactions for shares not yet admitted to trading which are performed as part of a capital increase are not covered.

Explanations on this are provided in the ESMA Q&As, particularly question 7e.

14a. Can sales in the course of when-issued dealing be subject to the ban on short selling under Article 12 of the EU Short Selling Regulation?

No, when-issued dealing is not subject to the ban on short selling under Article 12(1) in conjunction with Article 1(1)(a) of the EU Short Selling Regulation as the shares are not admitted to trading at that point in time.

Example:

Shares of issuer W are intended to be offered to the public and therefore admitted to trading on the regulated market. Prior to their issue and to the admittance of the shares of issuer W to the regulated market, a market participant performs an uncovered short sale of these shares. This short sale does not fall under the ban on short selling of Article 12(1) of the EU Short Selling Regulation.

15. Can claims to shares not yet issued (subscription rights) cover a short sale?

Subscription rights are (in theory) also suited to cover a short sale. Due to the fact, that, as a matter of principle, subscription rights only carry a claim against the issuer to conclude the subscription agreement, they do not per se represent a claim to the shares which are sold short. Subscription rights can therefore only cover a short sale if the availability of the new shares for settlement is ensured when settlement is due. This can de facto not be the case until the capital increase is recorded in the commercial register. After all, it is not until this point that the purchaser is effectively entitled to the transfer of the shares and that the time of delivery is known. A contingent capital increase does not necessarily become effective on recording in the commercial register. Rather, it is effective when the subscription shares are issued. It is therefore not until the subscription shares are issued that it is possible to assess whether the short sale will be able to be settled and whether the new shares are suitable as coverage

See also question 7f. of the ESMA Q&As.

16. Is the conclusion of a locate arrangement sufficient to cover a short sale in shares?

Yes, conclusion of a locate arrangement (agreement with a suitable third party inter alia that the shares were located and are capable of being delivered to the short seller) may, subject to certain conditions, cover a short sale in shares. These conditions are defined in more detail in Article 6 of Regulation (EU) No 827/2012.

The requirements to be satisfied by locate arrangements for shares are explained in more detail in Questions 17 to 20.

17. What requirements do locate arrangements for shares generally have to meet?

Standard locate arrangements and measures for shares are arrangements, confirmations and measures that pursuant to Article 6(2) of Regulation (EU) No 827/2012 include a locate confirmation and a put on hold confirmation.

The locate confirmation is a confirmation by a suitable third party (see Question 25) given prior to the short sale being entered into that the number of shares covering the short sale can be made available for settlement in due time. The locate confirmation must also indicate the period for which the share is located.

The put on hold confirmation is a confirmation by the suitable third party (see Question 25) given prior to the short sale being entered into that the requested number of shares has been put on hold for a person.

Pursuant to Article 6(5) of Regulation (EU) No 827/2012, proof of existing arrangements, confirmations and instructions must be stored on a durable medium.

18. What requirements do standard locate arrangements and measures for shares have to meet which are solely aimed at coverage on the day of the short sale?

Locate arrangements and measures aimed solely as coverage on the day of the short sale (same day locate arrangements) must meet the following facilitated requirements pursuant to Article 6(3) of Regulation (EU) No 827/2012:

Firstly, a request for confirmation must be made by the short seller to a suitable third party (see Question 25) stating that the short sale will be covered by purchases during the day on which the short sale takes place.

Furthermore, a locate confirmation from the suitable third party (see Question 25) is required. The locate confirmation is a confirmation by a third party given prior to the short sale being entered into that the number of shares covering the short sale can be made available for settlement in due time. The locate confirmation must also indicate the period for which the share is located.

Moreover, the suitable third party must confirm that the share is easy to borrow or purchase taking into account the market conditions and other information available on the share. In the absence of such confirmation by the third party, the latter must confirm that it has at least put on hold the shares.

The short seller furthermore has to undertake to monitor the amount of the short sale not covered by purchases. In the event that executed short sales are not covered on the same day, the short seller must promptly instruct the suitable third party to procure the shares to cover the short sale to ensure settlement in due time.

Pursuant to Article 6(5) of Regulation (EU) No 827/2012, proof of existing arrangements, confirmations and instructions must be stored on a durable medium.

19. What requirements do locate arrangements have to meet for liquid shares?

For liquid shares (which are defined by Article 22 of Regulation (EC) No 1287/2006 (MiFID Implementing Regulation)), the locate arrangement is subject to facilitated requirements (Article 6(4) of Regulation (EU) No 827/2012). Also for other shares listed in the most important national share index as determined by the national supervisory authority (e.g. the DAX in Germany), such facilitated requirements are sufficient for coverage provided that these shares constitute the underlying instrument for a derivatives contract admitted to a trading venue.

Pursuant to Article 6(4) of Regulation (EU) No 827/2012, a locate confirmation from the suitable third party (see Question 25) is first of all required. The locate confirmation is a confirmation given prior to the short sale being entered into that the number of shares covering the short sale can be made available for settlement in due time. The locate confirmation must also indicate the period for which the share is located.

Moreover, the suitable third party must confirm that the share is easy to borrow or purchase taking into account the market conditions and other information available on the share. In the absence of such confirmation by the third party, the latter must confirm that it has at least put on hold the shares.

The short seller must further undertake to instruct the third party in the event that his/her short sales are not covered to procure the shares to cover the short sale to ensure settlement in due time.

Pursuant to Article 6(5) of Regulation (EU) No 827/2012, proof of existing arrangements, confirmations and instructions must be stored on a durable medium.

20. Is the conclusion of a locate arrangement sufficient to cover a short sale in sovereign debt?

Yes, conclusion of a locate arrangement (agreement with suitable third party inter alia that the sovereign debt was located and, if required, capable of being delivered to the short seller) may, subject to certain conditions, cover a short sale in sovereign debt. These conditions are defined in more detail in Article 7 of Regulation (EU) No 827/2012.

The requirements to be satisfied by locate arrangements for sovereign debt are explained in more detail in Questions 21 to 24.

21. What requirements do locate arrangements for sovereign debt generally have to meet?

Pursuant to Article 7(2) of Regulation (EU) No 827/2012, a locate confirmation serves as a standard locate arrangement for sovereign debt. Such locate confirmation is a confirmation by a suitable third party (see Question 25) given prior to the short sale being entered into that the sovereign debt covering the short sale can be made available for settlement in due time in the relevant quantity. The locate confirmation must also indicate the period for which the sovereign debt is located.

Pursuant to Article 7(6) of Regulation (EU) No 827/2012, proof of existing arrangements, confirmations and instructions must be stored on a durable medium.

22. What requirements does a standard sovereign debt locate arrangement have to meet which is solely aimed at coverage on the day of the short sale?

Pursuant to Article 7(3) of Regulation (EU) No 827/2012, time limited arrangements may be sufficient as a locate arrangement if aimed solely as coverage on the day of the short sale (same day locate arrangements). Such time limited arrangement within the meaning of Article 7(3) of Regulation (EU) No 827/2012 is a confirmation of the short seller that the short sales can be covered by purchases during the day of the short sale. In addition, the suitable third party (see Question 25) must confirm that it has reasonable expectation that coverage will be procured taking into account the information available on the day of the short sale and the market conditions.

Pursuant to Article 7(6) of Regulation (EU) No 827/2012, proof of existing arrangements, confirmations and instructions must be stored on a durable medium.

23. Is a repo confirmation by a suitable third party sufficient to cover a short sale in sovereign debt?

Pursuant to Article 7(4) of Regulation (EU) No 827/2012, an unconditional repo confirmation by a suitable third party (see Question 25) given prior to the short sale being entered into may also be sufficient as coverage for a short sale. This is understood as a confirmation by the third party that it has reasonable expectation that the sovereign debt can be purchased in the quantity required for coverage in due time by reason of its participation in a system operated by certain entities that provides it with unconditional access to the sovereign debt in question.

Pursuant to Article 7(6) of Regulation (EU) No 827/2012, proof of existing arrangements, confirmations and instructions must be stored on a durable medium.

24. Is the confirmation by a suitable third party that the share is easy to borrow sufficient to cover a short-selling transaction in sovereign debt?

A confirmation by the suitable third party (see Question 25) given prior to the short sale being entered into that the sovereign debt is easy to purchase or borrow may also suffice as coverage for the short sale pursuant to Article 7(5) of Regulation (EU) No 827/2012. According to the confirmation, the third party must have reasonable expectation that the sovereign debt is easy to purchase or borrow in the quantity required for coverage in due time. The expectation is reasonable if it takes into account the market conditions and the information available on the supply of the sovereign debt.

Pursuant to Article 7(6) of Regulation (EU) No 827/2012, proof of existing arrangements, confirmations and instructions must be stored on a permanent data carrier.

25. Who are suitable third parties for a locate arrangement?

Pursuant to Article 8(1)(b), (c), (d) and (e) of Regulation (EU) No 827/2012, a locate arrangement from central counterparties, securities settlement systems, central banks and national debt management entities suffices without further requirements.

Investment firms, other persons subject to authorisation or registration requirements of a member of the European System of Financial Supervision, and persons established in a third country and subject to supervision by an authority in that third country (provided such supervisory authority is a party to an appropriate cooperation arrangement) must meet further requirements. Pursuant to Article 8(2) of Regulation (EU) No 827/2012, such third parties are required to participate in the management of borrowing or purchasing the securities and to be able to provide evidence of such participation. On request, they must also be able to provide evidence (including statistics) of their ability to deliver or process the delivery of the securities.

26. Can the conditions for coverage of a short sale be fulfilled if coverage exists at another legal entity within a group?

No, coverage of a short sale cannot be effected through fulfilment of the conditions for coverage pursuant to Article 12(1)(a)-(c) or Article 13(1)(a)-(c) of the EU Short Selling Regulation by another legal entity within a group by e.g. such legal entity entering into a locate arrangement within the meaning of Article 12(1)(c) or Article 13(1)(c) of the EU Short Selling Regulation. The conditions of Article 12(1)(a)-(c) and Article 13(1)(a)-(c) of the EU Short Selling Regulation in each case must be fulfilled by the legal entity that effects the short sale. However, the selling legal entity may, e.g., enter into a locate arrangement with another legal entity of a group in order to effect coverage.

27. Can a short sale in sovereign debt be covered by the purchase of another debt instrument?

Pursuant to Article 13(2) of the EU Short Selling Regulation, the restrictions set out in Article 13(1) of the EU Short Selling Regulation do not apply if the transaction (i.e. the short sale) is intended to hedge a long position in debt instruments of an issuer, the pricing of which has a high correlation with the pricing of the given sovereign debt.

Example:

If a trading participant sells short a German government bond and this serves as coverage for a corporate bond, no uncovered short sale exists if the prices of both debt instruments are highly correlated.

Other questions

28. Is there an obligation for banks and financial services providers to report a suspected contravention of Articles 12 and 13 of the EU Short Selling Regulation?

Investment services enterprises, other credit institutions, asset management companies (Kapitalanlagegesellschaften) and operators of off-exchange markets on which financial instruments are traded are required pursuant to section 10 of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG) to notify BaFin without undue delay of any facts giving rise to suspicions of a contravention of the ban on short selling of Articles 12 and 13 of the EU Short Selling Regulation.

For this purpose, the form provided on the BaFin website is to be used.

29. How will any contraventions of the ban on short selling or the obligation to notify suspected contraventions be sanctioned?

Contraventions of the ban on uncovered short sales in shares and sovereign debt (Articles 12 and 13 of the EU Short Selling Regulation) will be punished pursuant to section 39 (4) of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG) by a fine of up to 500,000 euros. Contraventions of the obligation to submit suspicious transaction reports in respect of uncovered short sales (section 10 (1) of the WpHG) carry a fine of up to 50,000 euros pursuant to section 39 (4) of the WpHG).

Note:
These FAQs are regularly updated by BaFin (last updated: 10 August 2015).

Please direct any queries you may have to +49 (0)228/4108-4004 or by e-mail to short-selling@bafin.de

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