Explaining Cross-Sectional Differences in Credit Default Swap

Regulating Short Selling: The
European Framework(s) and
the Regulatory Arbitrages
Giampaolo Gabbi and Paola Giovinazzo
Reading Questions
Which is the difference between the regulatory and the fundamental
view on short selling?
Did all the European countries introduce prohibitions for short sellers
after the crisis?
Did European Market Authorities introduce a regulation on short selling
after the financial crisis in the same time and for the same duration?
Is the European regulation on short selling based upon an harmonized
Which is the purpose of the short selling regulation in the United
Why Germany introduced a restriction on short selling for bonds in
January 2010?
Which are the main features of the French regulation on short selling?
Why the Italian Authority decided to use moral suasion before restricting
short selling activities?
How short selling regulation has been calibrated in European countries?
Which is the impact of heterogeneous regulations in Europe?
1. The regulatory view vs. the
fundamental view
According to the regulatory view, short selling
amplifies price collapse when uncertainty and
information asymmetries converge towards a negative
This is the rationale by which, financial market
authorities introduced different types of bans in order
to avoid speculative forces destabilizing financial
On the other side, according to the fundamental view
short sellers use information to influence the
convergence of asset market prices to their fair values.
2. European countries decisions
after the crisis
A majority of European countries introduced
restrictions on short selling activities during the months
of September and October 2008.
Their range and number of restricted assets were
partly diverse with different durations.
The are some countries that did not introduce any type
of restriction on short selling.
These countries are the Czech Republic, Finland,
Hungary, Poland, Slovenia and Sweden
3. When European Authorities
introduce their regulation
European Countries who decided to introduce short
selling restrictions, implemented the ban after the
Lehman Brothers collapse
The first countries to introduce restrictions, on 19th
September 2008 (that is 4 days after the bankruptcy),
were Ireland, Luxembourg, Switzerland and the UK.
The last country to introduce restrictions was Belgium,
on 26th October 2008
On average, restrictions delayed 13 days after the
Lehman collapse.
This heterogeneity affected the European market
equality and the opportunistic behaviour of some
financial players
4. The European regulation
framework on short selling
The prohibition of short selling of all stocks listed in the market
arises some indirect costs: pricing efficiency, liquidity shortage,
foregone profits and consequent trading reduction.
Therefore, regulators when introduce such bans need to avoid
any type of regulatory asymmetry among countries and financial
This risk is higher when regulations are managed by agencies
with heterogeneous organizations, missions, and supervisory
tools. This is what still happens in Europe, where besides a
common Financial Markets Directive (aka Markets in Financial
Instruments Directive (MiFID), there is at least one supervisory
authority for each single country.
This could be considered a critical point of the European financial
markets, for the existence of many agencies and frameworks
where short selling is regulated and supervised
5. The purpose of the short selling
regulation in the United Kingdom
In the UK, the Financial Services Authority (FSA)
introduced new provisions to the previous Code of
Market Conduct to forbid the formation or the increase
of net short positions for both naked and covered short
sales in publicly quoted financial stocks. The main
purpose is stated as follows:
“to protect the fundamental integrity and quality of
markets and to guard against further instability in the
financial sector…”
Financial Services Authority (2008) “FSA statement on short positions in
financial stocks”.
6. The rationale of restriction on
bonds in Germany
On January 18, 2010 the ban for naked short selling on
financial stocks was reintroduced for sovereign bonds
issued by European countries and for credit default
swaps brokers.
The purpose was to support bond prices during the Euro
crisis and the speculative pressure against Greece.
Since this regulation was that it applied only for the
domestic market, all banks outside Germany could
continue taking short positions on sovereign bonds,
however, most of the large banks, decided to manage
short selling operations from their foreign offices.
7. The main features of the French
The French Authority (AMF) wanted to “provide as much
consistency as possible between the Paris marketplace
and major foreign financial centres, in particular those
that are home to markets operated by Euronext”.
Therefore, AMF banned naked short selling and
requested that financial institutions abstain from
securities lending transactions in financial stocks.
Short positions generated through the use of derivatives,
such as futures were also banned.
8. The effectiveness of moral
suasion in short selling
The Italian Market Authority (CONSOB) after the
Lehman collapse decided to apply the moral suasion as
a means of intervention to reduce the activity of short
The purpose was to reduce speculative activities against
financial stocks during the crisis
The impact was considered inadequate for the
magnitude of the crisis and, three days later, CONSOB
decided to ban naked short selling.
9. The approaches to calibrate short
selling regulation in Europe
The direct approach defines objectively restrictions to short
selling by assets and market players, taking into consideration
covered and naked short selling; investors’ activity and
The disclosure approach requires more information on trading
activity from financial firms in order to monitor short selling
volumes and increase the disclosure. The information can be
provided to regulators or directly to the market
The mixed approach combines the previous two approaches,
in order to minimize the negative short selling impact and
supervise more effectively financial speculation.
In Europe 4 countries applied the direct approach and 10
countries the mixed approach. Only Italy initially choose the
disclosure approach, almost immediately suspended.
10. The impact of heterogeneous
regulations in Europe
“While the actual effects of this temporary action will not
be fully understood for many more months, if not years,
knowing what we know now, I believe on balance the
Commission would not do it again. The costs (of the
short selling ban on financials) appear to outweigh the
Christopher Cox, Chairman of the SEC
Our study shows that European countries suffered of the
disadvantage of a heterogeneous short selling regulation
system which induced opportunistic behaviours.
The implication is that imperfect harmonization among
regulators reduces the expected response of market
players and increases the risk of competitive distortions,
creating an advantage for a few players.
This analysis provided insight into:
The regulatory framework of short sales in European countries,
particularly Germany, France, Italy and the UK
The rationales of short sales restrictions in Europe
The impact of the short sale prohibition differences in European
The need for a homogeneous and coordinated set of rules in
countries where many financial players can freely settle and
operate with a license given by the home country regulator