Cross-Border Hedge Fund Industry Praises BaFin Approach tp Short Sale Disclosure

U.S. and German hedge fund industry groups commended the regulatory approach to short sale disclosure adopted by Germany’s Federal Financial Supervisory Authority (BaFin), athough the Managed Funds Association has concerns about the details of the requirements for investors to disclose net short sale positions at certain thresholds. The BaFin General Decree mandates a two-tier transparency system for the private reporting of net short-selling positions in selected financial stocks at a threshold of 0.2% or more, and further anonymous disclosure to be posted on the BaFin homepage at a level of 0.5% or more of the selected stocks. The new requirements will be implemented on March 25, 2010 and are scheduled to be enforced until January 31, 2011. The General Decree is oriented on the CESR proposals for a pan-European transparency system for net short-selling positions.

The MFA, headed by former US Rep. Richard Baker, believes that BaFin has taken a responsible approach to increasing regulator access to short selling information while also protecting investors, and encourages other regulators to strike the same balance. The German Alternative Investments Association also supports BaFin’s effort to preserve investor participation and confidence in markets by keeping short position reporting private and, when made public, anonymous.

The MFA also believes that public disclosure of short position information should be done in a manner that mitigates costs to investors. MFA urges BaFin to clarify the details of the reporting requirements in order to assist investors seeking to implement operational procedures to efficiently report the appropriate data. The BaFin approach recognizes that market abuse is distinct from legitimate short selling, which allows investors to mitigate risk, provide needed liquidity to markets, and aid in capital formation.

For its part, the MFA strongly supports efforts to prevent market manipulation and abuse because, as investors, MFA members have a strong interest in stable, liquid, and honest markets. The MFA urges BaFin to track, analyze, and make public the impact of its disclosure requirements on the functioning of equity markets. Such data will enable BaFin and market participants to better judge the effectiveness of the regulations at the end of the enforcement period, said the industry group.

The BaFin short sale disclosure provision relate to all transactions which, in terms of the holder’s aggregate economic interest, result in a net short-selling position in shares of enumerated financial institutions, including Deutsche Bank and Allianz Se. A net short-selling position arises if the aggregation of the holder’s financial instruments results in a net exposure on the short side. This applies regardless of whether the underlying transaction was concluded in Germany or abroad, emphasized BaFin, or on a regulated market or OTC. There is an exemption for market makers to the extent the transaction is required for performance of their contractual obligations.

Further, all types of financial instruments have to be included in the calculation, including option transactions, swaps and financial instruments that are based on indices and baskets and at least partly include the specified stocks. Inclusion of such financial instruments takes place regardless of a minimum percentage by which the specified financial stocks have to be represented in the respective product.

BaFin will not allow the netting of positions within a group with reference to one of the stocks specified. Also, within group structures, the notification must take place at the level of the respective legal entity. In the case of investment funds, no netting takes place at the level of the respective investment company; instead, the net short-selling positions of the individual common funds must be disclosed.

There is no additional obligation for financial institutions to monitor compliance with the provisions. However, this is without prejudice to the obligation to report suspicious transactions pursuant to German law. BaFin recommends that financial institutions draw their customers’ attention to the General Decree. The German federal regulator also cautioned that the deliberate submission of false notifications may constitute a violation of the prohibition of market manipulation under German law.

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