In order to ensure a level playing field, consistency of market practices and convergence of regulatory practices, the European Securities and Markets Authority has issued guidance under the provisions of the E.U. Short Selling Regulation providing an exemption for market making activities and primary market operations. The Regulation prescribe the notification of intent to make use of the exemption to be made to the home Member State for the market making exemption and the relevant competent authority of the concerned sovereign debt for the authorized primary dealer exemption, while the exempted activities might also take place in other jurisdictions outside the supervisory remit of that authority. In the case of third country entities not authorized in the E.U., the notification has to be sent to the competent authority of the main trading venue in the Union in which the third country entity trades.
ESMA noted that the exemption only covers activities when, in the particular circumstances of each transaction, they are genuinely undertaken in the capacity of market making as defined in the Regulation. Thus, persons notifying of the intent to make use of the exemption are not expected to hold significant short positions, in relation to market making activities, other than for brief periods. Arbitrage activities, particularly those executed between different financial instruments but with the same underlying security, are not considered market making activities under the scope of the Regulation and therefore cannot be exempted.
The over-riding principle for all asset classes is that an entity notifying its intention to make use of the exemption for its market making activities must provide liquidity to the market on a regular and ongoing basis by posting firm, simultaneous two-way quotes of comparable size and at competitive prices. Market making activities that are exempted under the Short Selling Regulation will be those where a person is offering prices that are competitive and in comparable sizes, in line with the specified qualifying criteria for at least the stated mandatory time presence where relevant.
When carrying out hedging activities under the Regulation, said ESMA, the size of the position acquired for the purpose of hedging should be proportionate to the size of the exposure hedged in order for these activities to qualify for exemption. The person should be able to justify upon request from the competent authority why an exact match in size was not possible. The discrepancy should, in all cases, be insignificant.
The Regulation defines market making activities, in part, as dealing as principal in a financial instrument. Consequently, the exemption applies to activities in a financial instrument, emphasized ESMA, on an instrument per instrument basis, and should not be considered as a global exemption for market making activities in general. The notification submitted when notifying of the intent to use the exemption, and further use of this exemption should, therefore, concern a financial instrument issued by a particular issuer subject to the Regulation, such as shares of an issuer falling under the regime and a sovereign issuer as defined by the Regulation.
Further, any such notification of the exemption should identify, with regard to shares, the individual instrument for which market making activities are notified for the purpose of exemption and, for sovereign debt and credit default swaps in sovereign debt if applicable, the sovereign issuer in the debt of which market making activities are notified for the purpose of the exemption.