Global Securities Regulators Follow SEC Lead and Ban Short Selling to Prevent Regulatory Arbitrage

Following the lead of the SEC and the UK Financial Services Authority, and in an effort to prevent regulatory arbitrage, securities regulators around the world have acted to ban forms of short selling as the crisis in the financial markets spreads globally. Countries which have now followed in banning or limiting short selling are Australia, France, Germany, Switzerland, Ireland and Canada (Ontario), and other regulators are assessing their responses.

The Australian Securities and Investments Commission has banned naked short selling and covered short selling subject to a limited authorized market-maker exemption. The Commission said that it would reassess and advise the market in 30 days whether or not it will at that time, or at a later date, reopen covered short sales for non-financial stocks. Because of the relatively small size and the structure of the Australian market, the Commission felt that it was necessary to extend the prohibition to all stocks. To limit the prohibition to financial stocks, as has been done in the UK, could subject other stocks to unwarranted attack given the unknown amount of global money which may be looking for short sell plays.

While emphasizing that it sees a legitimate place for short selling in markets, the Commission believed that in the current climate and, in light of the actions taken by other regulators, the market needed a circuit breaker to assist in maintaining and restoring confidence. These measures will operate for a limited time and in the case of non-financial stocks, will be reviewed in 30 days. In the case of financial stocks, the review will be in line with the time limits imposed by other international regulators such as the SEC and the FSA.

The Netherlands Financial Markets Authority took measures concerning the naked short selling of shares issued by financial companies. The measures concern shares issued by financial companies which are traded on the Euronext Amsterdam stock exchange; these shares concern transactions performed on own account or on behalf of third parties, with the exception of transactions performed by intermediaries acting as cash market maker or counter party in block trade transactions. All selling orders resulting in postponed settlement/delivery concerning one of the shares involved must be covered for 100% by the financial instruments that are the subject of the selling orders.

Thus, the AFM’s prohibition only applies to uncovered short positions as a result of selling orders in shares issued by financial companies. It does not apply to covered short positions resulting from selling orders in shares issued by financial companies. Market makers on the derivatives market and liquidity providers on the cash market, as defined by the Rulebook of Euronext, are exempt, as well as block trade counterparties. Market makers and liquidity providers designated by Euronext are only exempt in this capacity with regard to the relevant financial institutions.
The German Federal Financial Supervisory Authority (BaFin) prohibited short selling of the shares of a number of financial institutions, including Deutsche Bank, Commerzbank, and Allianz SE. The ban expires at the end of the year, but BaFin vowed to review it on an ongoing basis. BaFin justified this move by the recent developments in the global capital markets.The legal basis for its decision was section 4 of the Securities Trading Act. Based on this, the regulator had to counteract undesirable developments that might result in serious disadvantages for the financial markets. The statute provides that BaFin may issue orders which are appropriate and necessary to eliminate or to prevent such undesirable developments.

Noting that SEC and the UK FSA prohibitions on short sales, the BaFin said that, given the close interdependence of the financial markets, it is likely that without this order there would be serious adverse effects for the conduct of orderly trading on German markets. Particularly given the current state of the capital markets, an influencing of the market prices of shares of certain credit institutions, stock exchange operators, insurance companies and other companies from the financial sector is resulting in excessive price movements that could jeopardize the stability of the financial system and thus lead to serious disadvantages for the financial market.

The Ontario Securities Commission issued a temporary order prohibiting short selling of securities of certain financial sector issuers that are listed on the Toronto Stock Exchange and are also interlisted in the United States. This order was issued as a precautionary matter with respect to short selling of the securities of financial sector issuers subject to the U.S. SEC short selling order and to ensure that Canadian markets are not used for purposes of regulatory arbitrage The Commission vowed to monitor trading in securities of other Canadian financial issuers and take action if necessary.