Short Trading Regulation: The Short Sale Definition

The short trading regulation. The term “short trading or selling” carries significantly different meanings in different jurisdictions. Market practices also vary in different markets. As a starting point toward a consistent approach to short selling, there must be a common understanding of what constitutes short-selling activity.

Short Trading Regulation

Short selling or trading is subject to the application of appropriate internal controls to reduce the potential risks that could affect the orderly and efficient functioning and stability of financial markets. In some jurisdictions, “short selling” is defined in the law or the rules.

For example, short selling is only allowed in some jurisdictions if it is “covered” short, that is the seller has borrowed the securities before the sale is executed. On the other hand, rather than defining ‘short trading or short selling’, some jurisdictions spell out what constitutes ‘prohibited’ activity about short selling.

To add, in some markets, prohibited short trading refers to ‘naked’ short trading or short selling, i.e. a short sale transaction where no prior arrangement is made to cover the short trade or sale.

Regimes To Control EU Securities Short-Selling

The Regulation related to short selling required to device a consistent regime to control the short-selling of EU securities including limitations on uncovered short selling, and disclosure requirements of short positions to the national competent authority (NCA), at initial thresholds, depending on the size of the position. The SSR applies to any natural or legal person short-selling shares listed on an EU trading platform, EU debt instruments, and credit default swaps.

The Regulation confirms that the transparency principle applies anywhere in the world where a short position is held by any person in EU shares securities. Sales under repurchase agreements are excluded from the purview of short sales in shares and debt securities.

The EU SSR introduced different rules and restrictions, such as the prohibition of short-selling of shares, except where covered by an appropriate arrangement giving reasonable certainty that settlement of the transaction shall be effected on the due date. The restriction on short-selling of debt securities gives reasonable clarity about the settlement on the due date. 

The Short Selling Amendment – EU Exit Regulations Of 2018

After the exit of the EU countries, from the UK jurisdiction, the short-selling regulations were enforced. As per Regulations, Short selling is the practice of selling a security that was borrowed by the seller to buy the security back at a later date and at a lower price, to make profits.

The EU SSR applies to the trading of the financial instruments traded on an EEA trading platform. The regulation applies to the debt instruments that are issued by EU issuers and related credit default swaps. As per SSR  holders of net short positions in shares shall make notifications of their positions to the national competent authority (NCA) after the breach of defined thresholds. The restrictions are placed on investors to uncover short positions and to maintain the settlement discipline in the market. The SSR  enables NCAs to control the downward trend in the share prices, which could otherwise create systemic risks leading to market stress.

To control the potential financial crisis, several EU countries, including the UK, suspended short selling, through the introduction of Regulations on short selling or trading. The regulations increased the transparency of the market and the short positions held by different investors in EU securities markets.

A consistent approach is implemented to control the short selling and undue fall in the share prices leading to market disequilibrium. The member states are required to notify before taking action to restrict the short selling. As the UK is not a part of the EU therefore, these provisions do not apply to it. The intervention of the European Securities and Markets Authority’s powers are also been removed. The FCA of the UK has the powers to control the short-selling activities, and significant fall in the share price to maintain market confidence.

Final Thoughts

The short-sale rule stated that shorts could only be placed at a price higher than the most recent trade, implying an increase in the share’s price. With only a few exceptions, the rule prohibited trading short on a drop in share price. The rule was also known as the “plus tick rule,” “tick-test rule,” and “uptick rule.”

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