German and UK Securities Regulators to Extend Prohibition on Short Selling, While Australia Lifts Ban

The German Federal Financial Supervisory Authority (BaFin) has extended its ban on naked short selling in the shares of financial companies to January 31, 2010. This is BaFin’s third extension of the prohibition, which was adopted in September of 2008. The companies affected by the ban include Allianz SE, Commerzbank AG, and Deutsche Bank AG. BaFin promised to ppromptly lift the ban in the event of a far-reaching stabilization of the markets.

Similarly, the UK Financial Services Authority proposes to extend the disclosure regime for significant net short positions in UK financial companies. The UK extension would have no fixed time limit. While acknowledging that market turbulence has lessened somewhat since the start of the year, the FSA believes that conditions are such that the enhanced transparency provided by the special regime remains warranted. However, the FSA emphasized that it does not intend for this to be a permanent regime. The FSA expects that the disclosure regime would either be superseded in due course by broader permanent disclosure measures, preferably agreed on an international basis, or be revoked. The FSA reaffirmed its belief that short selling is a legitimate investment technique in normal market conditions.

At the same time, the Australia Securities and Investments Commission lifted the ban on short selling in the stock of financial institutions, noting that the balance between market efficiencies and potential systemic risk has now moved in favor of the ban being lifted. The Commission’s approach to short selling during the crisis has now gone through three phases. In early 2008, the Commission resisted considerable pressure to impose a ban because the ASIC felt that the benefits of short selling outweighed possible systemic issues. Later in the year, the Commission imposed a ban when the combination of lack of confidence in the market and the state of the international financial markets put the odds too much in favor of the short sellers. The third phase is the gradual lifting of the ban. In November 2008, the Commission reopened the securities of non-financials to short-selling, but concern with potential systemic issues in the financial sector remained until now, when the ASIC has reopened the financials.

Bafin defines naked short selling as when sellers sell shares which they do not own or for which they do not have a plea-proof claim to transfer of title in shares of the same class at the time of the transaction. By influencing the prices of the stocks specified, transactions resulting in a short position or in the increase of a short position (referred to as short selling transactions) in shares within the meaning of the ban would, by reason of the importance of the companies for the aggregate economy, reinforce this development and result in further excessive price movements, thereby jeopardizing the stability of the financial system.

BaFin noted that short share positions created by the exercise of option transactions are not subject to the ban. Although the sale of a short call option is a transaction, it does not yet result in a short position in shares. The short position arises only when the call option is exercised, explained BaFin, since it is only at this point of time that a delivery obligation arises with the option writer. Similarly, BaFin said that the ban does not extend to the sale of futures since the d decree only refers to naked short transactions in shares.

The BaFin ban does not apply to short sales backed by securities lending. The decree only prohibits naked transactions in the specified shares that are not backed by securities lending. According to BaFin, the securities lending transactions have to have been concluded prior to, or at least simultaneous with, the respective transaction. It is sufficient that at the time of the conclusion of the transaction an absolutely enforceable legal claim on the borrowed shares already exists. It is not necessary that the shares have already been booked into the account of the borrower.