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-ban
Temporary ban
Prohibit short
selling
Unless seller has a
presently existing and
unconditional right to
vest products in the
buyer a
1.
Exceptions
1.
2.
3.
4.
5.
Odd lot
Arbitrage t/as
Prior purchasing
Prior borrowing
ASX Approved SS
list
2.
Post-ban
Ban all for period
no change from (2) in
Ban all in S&P/ASX temporary ban
200 Financials
Index + 5, but other
short sales allowed
if comply with s
1020B(2) + (3)
None initially then
1.Hedging
2.Exercise ASX ETOs
1.
2.
Prior purchasing
Exercise of ETO,
unobtained
financial products
and certain bonds
and debentures
Disclosure on T+1
basis



Client tells
FSL’EE who tells
market



FSL’EE inquiry



Approach: FSA
Pre-ban
Temporary ban
Post-ban
Failing to make
T+1 disclosure of
DSP in security
subject to rights
issue (June 08)
 Entering
Failure to make
T+1 disclosure of
DSP (0.25%,
0.35%, 0.45%,
0.55% then every
0.1%)
Prohibit short
selling
Deemed market
abuse
into or
increasing a net
short position in
UK Financial
company
 Failure to make
T+1 disclosure
of DSP
(thresholds)
Approach: SEC
Pre-ban
Temporary ban
Post-ban
pre-borrow for19 FI
then banned for 799
FI
Pre-ban situation
Prohibit short selling

Exceptions


Disclosure on T+1
basis


Tagging of order

No change
No change
C-B-M note

No change
No change


Weekly report on gross
short positions
including intraday
positions
Locate rule
Hard close-out
Yes but option
market maker
exception
No exceptions
T+4
Same as temporary
ban
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.
2.
3.
4.
A short position or a short sale
Net or gross positions
How timely must the disclosure be?
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 58166 (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
 Who‘s going to process all the information gained
from different disclosures?
