Short selling of securities
Regulation (EU) No 236/2012 on short selling and certain aspects of credit default swaps
It seeks to regulate certain aspects of short selling* and credit default swaps (CDS)* in the European Union (EU).
KEY POINTS
In times of financial instability, certain financial transactions such as short selling, ‘naked short selling’* and credit default swaps bear the risk of aggravating any downward spiral in the prices of shares, especially in banks, threatening their viability and creating risks to the whole banking system.
Such instability in the financial markets can spill over into the real economy.
The regulation lays down strict rules on short selling and certain aspects of credit default swaps, in proportion to the risks associated with them, including:
measures to prevent ‘naked’ short selling of shares and loans issued by governments (called ‘sovereign debt’);
a ban on ‘naked’ CDS transactions (including on sovereign debt).
Disclosure requirements – financial institutions have to disclose certain short selling transactions to the banking authorities. Larger ones – above a certain threshold – must be publicly disclosed to the markets.
In periods of exceptional financial instability, the competent authorities in any EU country can temporarily restrict short selling if the price of the securities in question is falling significantly.
A proposed suspension has to be notified to other national authorities and to the European Securities and Markets Authority that must then issue an opinion on it.
KEY TERMS
Short selling: a transaction in which a financial institution sells a financial product it has borrowed, with the aim of buying it back later. The institution hopes that in the meantime the price of the product will have declined, so it has to pay less than the price it obtained from the sale.
Credit default swaps (CDS): highly risky, unregulated derivatives.
Naked short selling: perceived as riskier than normal short selling – when the seller has not even borrowed the financial product in the first place.
DOCUMENTS
Regulation (EU) No 236/2012 of the European Parliament and of the Council of 14 March 2012 on short selling and certain aspects of credit default swaps (OJ L 86, 24.3.2012, pp. 1–24)It has applied since 1 November 2012.
Successive amendments to Regulation (EU) No 236/2012 have been incorporated in the original text. This consolidated version is of documentary value only.
Regulation (EU) 2016/1033 of the European Parliament and of the Council of 23 June 2016 amending Regulation (EU) No 600/2014 on markets in financial instruments, Regulation (EU) No 596/2014 on market abuse and Regulation (EU) No 909/2014 on improving securities settlement in the European Union and on central securities depositories (OJ L 175, 30.6.2016, pp. 1–7)
Financial collateral arrangements – improving legal clarity
Directive 2002/47/EC – financial collateral arrangements – improving legal clarity
This Directive aims to create a clear uniform EU legal framework for the use of securities and cash as collateral* in financial transactions.
KEY POINTS
The Directive applies to certain specified categories such as central banks and supervised financial institutions. EU countries may, however, exclude specific categories such as unincorporated firms i.e. that do not have the legal status of a company.
The Directive applies to financial collateral including cash and financial instruments such as shares and bonds. Certain opt-outs are permitted by EU countries such as the collateral provider’s own shares.
The Directive sets down minimum formal requirements by EU countries concerning collateral arrangements including, for example, that such arrangements must be evidenced in writing or in a legally equivalent manner.
Enforcement of collateral arrangements by the collateral taker is possible, for example by sale or appropriation of the financial instruments.
The collateral taker has a contractually agreed right to use the financial collateral provided as if he were full owner. If he chooses to exercise this right, he is obliged to transfer back the equivalent amount of collateral.
EU countries must recognise close-out netting* arrangements, even if the collateral taker or provider is subject to insolvency proceedings or reorganisation.
EU countries are blocked from applying their national insolvency rules to financial collateral arrangements in certain cases. Such arrangements may not be declared invalid or void in order, for example, to take account of changes in market value.
KEY TERMS
Financial collateral is the property (such as securities) provided by a borrower to a lender to minimise the risk of financial loss to the lender if the borrower fails to meet their financial obligations to the lender.
Close-out netting is a legal mechanism that reduces the risks between 2 counterparties. Upon the default of 1 of the 2 counterparties, all future claims and contractual relations between them become due, calculated, netted and then set off. What finally remains for actual payment can be a small fraction only of the initial gross claim between those 2 parties.
ACT
Directive 2002/47/EC of the European Parliament and of the Council of 6 June 2002 on financial collateral arrangements
Directive 2002/47/EC
Directive 2009/44/EC
Directive 2014/59/EU
Report from the Commission to the European Parliament and the Council: Evaluation Report on the Financial Collateral Arrangements Directive (2002/47/EC) (COM(2006) 833 final of 20.12.2006)
Settlement finality in payment and securities settlement systems
Transfers and payments of financial products must be regulated to avoid major risks, especially those linked to the insolvency of participants – in the transaction. This EU law lays down rules to minimise such risks.
Directive 98/26/EC of the European Parliament and of the Council of 19 May 1998 on settlement finality in payment and securities settlement systems.
It guarantees that financial product transfer and payment orders can be finalised, mainly by mitigating problems arising from a participant’s insolvency. These participants may be:
financial institutions, e.g. banks;
systems operators, such as central securities depositories.
KEY POINTS
Transfer orders are irrevocable
Transfer orders of financial products are contractually enforceable. This is also applicable to any associated payment netting, situations where debt and claims are offset between participants.
The rules apply even when a participant is subject to insolvency proceedings, as long as the transfer order was underway before the proceedings started. The rules may also apply up to 24 hours afterwards to cover situations where transactions are entered into at times when relevant records are unavailable, for instance overnight.
Uniform rules
The directive seeks to ensure that uniform rules are applied where multiple settlement and payment systems are in operation from the moment the transactions are entered into in order to avoid difficulties arising from incompatible regulations.
Guarantees in insolvency situations
The existence of insolvency proceedings against a participant does not retroactively affect the rights and obligations of other participants nor their access to the
It originally took effect in 1998, since when it has been amended several times.
For more information, see the financial services and capital markets union page of the European Commission’s website.
REFERENCES
Directive 98/26/EC
Directive 2009/44/EC
Directive 2010/78/EU
Regulation (EU) No 648/2012
Regulation (EU) No 909/2014
Successive amendments and corrections to Directive 98/26/EC have been incorporated in the basic text. This consolidated version is for reference purposes only.
Improving securities settlement in the EU
Regulation (EU) No 909/2014 on improving securities settlement in the European Union and on central securities depositories
It aims to harmonise the timing and conduct of securities settlement in the European Union (EU) and the rules for central securities depositories (CSDs)* which operate the settlement infrastructure.
It is designed to increase the safety and efficiency of the system, particularly for intra-EU transactions.
KEY POINTS
The regulation introduces:
shorter settlement periods: in general, these should take place no later than the second business day after the trading occurs;
an obligation to record in book-entry form* all transferable securities admitted to trading or traded on the trading venues;
settlement discipline: CSDs must operate a penalty system, including cash fines, to deal with settlement failures.
EU countries’ national authorities:
authorise and supervise CSDs. This includes a review on at least an annual basis;
exchange information and cooperate with each other and the European Securities and Markets Authority (ESMA).
CSDs must:
have robust governance arrangements, a clear organisational structure, internal controls and sound administrative and accounting procedures;
ensure senior management is of sufficiently good repute and experience;
establish user committees for each securities settlement system they operate;
maintain for at least 10 years all records of their services and activities;
remain fully responsible for any work they outsource;
display transparency by publicly disclosing the prices and fees involved in the core services they provide;
have sufficient capital to be adequately protected against operational, legal, custody, investment and business risks;
secure additional authorisation before providing any banking-type ancillary services.
CSDs in a non-EU country may operate through an EU-based branch, provided they meet certain requirements.
ESMA maintains a publicly available register of each authorised CSD.
Alongside the right to impose criminal sanctions, EU countries’ competent authorities have the power to apply appropriate administrative sanctions and other measures for an infringement.
BACKGROUND
Book-entry form requirements (Article 3(1)) apply from 1 January 2023 to transferable securities issued after that date and from 1 January 2025 to all transferable securities.
The regulation’s settlement date rules (Article 5(2)) apply from 1 January 2015.
Settlement across borders presents higher risks and costs for investors than domestic operations. At the same time, this form of transaction is increasing. Traditionally, CSDs have been regulated nationally.
]The legislation provides a common set of prudential, organisational and conduct of business standards for use across the EU, whose existence will play a crucial role in financing the economy.
DOCUMENT
Regulation (EU) No 909/2014 of the European Parliament and of the Council of 23 July 2014 on improving securities settlement in the European Union and on central securities depositories and amending Directives 98/26/EC and 2014/65/EU and Regulation (EU) No 236/2012 OJ L 257, 28.8.2014, pp. 1-72)
Successive amendments to Regulation (EU) No 909/2014 have been incorporated in the original text. This consolidated version is of documentary value only.
Transparent securities financing transactions
Regulation (EU) 2015/2365 on transparency of securities financing transactions and of reuse
It increases the transparency of certain activities in financial markets, such as the use of securities financing transactions (SFTs)* and of collateral* reuse*, so that they can be monitored and the risks identified.
The regulation establishes EU rules for the reporting of details of SFTs to trade repositories, for information on SFTs and total return swaps* to be disclosed to investors in collective investment companies, and for minimum transparency conditions to be met by the parties involved in collateral reuse.
Reporting
Counterparties to SFTs have to report the details of any SFT they have concluded, as well as any modification or termination, to a central database (‘trade repository’) registered with the European Securities and Markets Authority (ESMA) or recognised in accordance with this regulation.
Those details must be reported no later than the working day following the conclusion, modification or termination of the transaction.
Counterparties must keep records of all SFTs that they have concluded, modified or terminated for at least 5 years following the termination of the transaction.
In this respect, ESMA must develop:
draft regulatory technical standards specifying the details of the reports for the different types of SFTs;
draft implementing technical standards specifying the format and frequency of the reports for the different types of SFTs.
These technical standards are subsequently scrutinised and adopted by the European Commission as delegated regulations or implementing regulations.
Transparency for investors
Managers of collective investment companies should include detailed information on their use of SFTs and total return swaps in regular reports so that investors are aware of the risks associated with their use.
A collective investment company’s investment policy with respect to SFTs and total return swaps should be clearly disclosed in the pre-contractual documents.
Transparency of reuse
To increase transparency on the extent of reuse of financial instruments provided as collateral, in particular regarding the respective risks and consequences, for example in the case of bankruptcy, the regulation imposes minimum information requirements.
Reuse should take place only under the following conditions:
the prior consent of the providing counterparty to a security collateral arrangement, or the express agreement to provide collateral by way of a title transfer; and
the transfer of the collateral from the account of the providing counterparty.
Cooperation between competent authorities
Competent national authorities and ESMA must cooperate closely and exchange information, in particular in to identify and remedy infringements of this regulation. The entities that have access to data stored in trade repositories (e.g. supervisory authorities) and the relevant members of the European System of Central Banks must also cooperate closely in accordance with certain conditions.
A competent authority may refuse to act on a request to cooperate and exchange information, in exceptional circumstances.
Professional secrecy
Any confidential information received, exchanged or transmitted pursuant to this regulation is subject to the conditions of professional secrecy.
Relationship with non-EU countries
The regulation grants the Commission the power to assess the rules of non-EU countries for the purposes of recognising trade repositories in non-EU countries, and in order to avoid potentially duplicate or conflicting requirements.
A trade repository established in a non-EU country may provide services to entities in the Union only after recognition by ESMA. ESMA must publish on its website a list of the trade repositories recognised in accordance with this regulation.
Sanctions
EU countries must ensure that competent authorities have the power to impose administrative sanctions and other administrative measures which are effective, proportionate and dissuasive.
Certain essential requirements apply in relation to the:
criteria to be taken into account when applying a sanction or measure;
publication of sanctions or measures;
nature and types of sanctions and measures;
levels of administrative monetary sanctions.
Delegated acts
The Commission has adopted a series of delegated acts supplementing or amending the regulation. These regulations supplement Regulation (EU) 2015/2365 with regard to regulatory technical standards:
specifying the details of SFTs to be reported to trade repositories;
on access to details of SFTs held in trade repositories;
on the collection, verification, aggregation, comparison and publication of data on SFTs by trade repositories; and
specifying the details of the application for registration and extension of registration as a trade repository.
Further delegated regulations concern:
the fees charged by the European Securities and Markets Authority to trade repositories; and
an amendment to the list of exempted entities (concerns UK (1) entities in the event of Brexit).
Implementing acts
The Commission has also adopted 3 implementing acts:
Regulation (EU) 2019/363 lays down technical standards for the format and frequency of reports on the details of securities financing transactions to trade repositories. It also amends Regulation (EU) No 1247/2012 with regard to the use of reporting codes in the reporting of derivative contracts;
Regulation (EU) 2019/364 lays down technical standards for the format of applications for registration and extension of registration of trade repositories;
Regulation (EU) 2019/365 lays down implementing technical standards for the procedures and forms for exchange of information on sanctions, measures and investigations.
Progress
Within 36 months of the entry into force of the regulatory technical standards that it adopts, the Commission must submit a report to the European Parliament and to the Council. This report will cover the effectiveness, efficiency and proportionality of the obligations laid down in this regulation and may be accompanied by appropriate proposals.
The Commission also submitted a report on progress in international efforts to mitigate the risks associated with SFTs on 19 October 2017.
FROM WHEN DOES THE REGULATION APPLY?
The regulation applies from 12 January 2016 but establishes the following phased-in implementation process:
Reporting to trade repositories: depending on the type of entity (e.g. bank, investment firm, central counterparty), reporting to trade repositories will start at different stages 12 to 21 months after the entry into force of the regulatory technical standards mentioned above.
Funds disclosure requirements in periodic reports apply since 13 January 2017. As regards pre-contractual documents, investment funds constituted before 12 January 2016 have had to disclose the use of SFTs and total return swaps in the pre-contractual documents since 13 July 2017, while funds constituted more recently had to do it as from 12 January 2016.
Transparency rules on collateral reuse: the reuse rules have applied since 13 July 2016.
The delegated and implementing regulations have applied since 11 April 2019. The delegated regulation relating to UK (1) entities will apply when the main regulation ceases to apply in the UK (1) following Brexit.
BACKGROUND
Securities financing transaction: this can refer to a number of transactions including:
a repurchase transaction (when a party sells a security, i.e. a financial asset such as a share or a government bond, and agrees to repurchase it in the future repaying the original sum of money plus a return for the use of that money);
a case where the lending counterparty lends securities for a fee in return for a guarantee in the form of financial instruments or cash given by their clients or counterparties;
a buy-sell back transaction or sell-buy back transaction; and
a margin lending transaction (e.g. where a counterparty extends credit in connection with the purchase, sale, carrying or trading of securities but the transactions do not include other loans that are secured by collateral in the form of securities).
Collateral: the provision of assets (e.g. securities) by a borrower to a lender to secure the performance of an obligation by:
transfer of full ownership from a collateral provider to a collateral taker (title transfer); or by
transfer of possession from a collateral provider to a collateral taker under a security right where the full ownership of the assets remains with the collateral provider (security collateral arrangement).
Reuse: the use by a receiving counterparty, in its own name and on its own account or on the account of another counterparty, of financial instruments received under a collateral arrangement.
Total return swap: a financial contract that transfers both the credit risk (e.g. a borrower’s ability to repay a loan) and market risk of an underlying asset (i.e. the financial instrument, such as a share or commodity, on which the price of a derivative is based).
DOCUMENTS
Regulation (EU) 2015/2365 of the European Parliament and of the Council of 25 November 2015 on transparency of securities financing transactions and of reuse and amending Regulation (EU) No 648/2012 (OJ L 337, 23.12.2015, pp. 1-34)
Commission Delegated Regulation (EU) 2019/463 of 30 January 2019 amending Regulation (EU) 2015/2365 of the European Parliament and of the Council with regard to the list of exempted entities (OJ L 80, 22.3.2019, pp. 16-17)
Commission Implementing Regulation (EU) 2019/363 of 13 December 2018 laying down implementing technical standards with regard to the format and frequency of reports on the details of securities financing transactions (SFTs) to trade repositories in accordance with Regulation (EU) 2015/2365 of the European Parliament and of the Council and amending Commission Implementing Regulation (EU) No 1247/2012 with regard to the use of reporting codes in the reporting of derivative contracts (OJ L 81, 22.3.2019, pp. 85-124)
Commission Implementing Regulation (EU) 2019/364 of 13 December 2018 laying down implementing technical standards with regard to the format of applications for registration and extension of registration of trade repositories in accordance with Regulation (EU) 2015/2365 of the European Parliament and of the Council (OJ L 81, 22.3.2019, pp. 125-127)
Commission Implementing Regulation (EU) 2019/365 of 13 December 2018 laying down implementing technical standards with regard to the procedures and forms for exchange of information on sanctions, measures and investigations in accordance with Regulation (EU) 2015/2365 of the European Parliament and of the Council (OJ L 81, 22.3.2019, pp. 128-133)
Commission Delegated Regulation (EU) 2019/356 of 13 December 2018 supplementing Regulation (EU) 2015/2365 of the European Parliament and of the Council with regard to regulatory technical standards specifying the details of securities financing transactions (SFTs) to be reported to trade repositories (OJ L 81, 22.3.2019, pp. 1-21)
Commission Delegated Regulation (EU) 2019/357 of 13 December 2018 supplementing Regulation (EU) 2015/2365 of the European Parliament and of the Council with regard to regulatory technical standards on access to details of securities financing transactions (SFTs) held in trade repositories (OJ L 81, 22.3.2019, pp. 22-29)
Commission Delegated Regulation (EU) 2019/358 of 13 December 2018 supplementing Regulation (EU) 2015/2365 of the European Parliament and of the Council with regard to regulatory technical standards on the collection, verification, aggregation, comparison and publication of data on securities financing transactions (SFTs) by trade repositories (OJ L 81, 22.3.2019, pp. 30-44)
Commission Delegated Regulation (EU) 2019/359 of 13 December 2018 supplementing Regulation (EU) 2015/2365 of the European Parliament and of the Council with regard to regulatory technical standards specifying the details of the application for registration and extension of registration as a trade repository (OJ L 81, 22.3.2019, pp. 45-57)
Commission Delegated Regulation (EU) 2019/360 of 13 December 2018 supplementing Regulation (EU) 2015/2365 of the European Parliament and of the Council with regard to fees charged by the European Securities and Markets Authority to trade repositories (OJ L 81, 22.3.2019, pp. 58-68)
Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories (OJ L 201, 27.7.2012, pp. 1-59)
Successive amendments to Regulation (EU) No 648/2012 have been incorporated into the original text. This consolidated version is of documentary value only.
Report from the Commission to the European Parliament and the Council under Article 29(3) of Regulation (EU) 2015/2365 of 25 November 2015 on transparency of securities financing transactions and of reuse and amending Regulation (EU) No 648/2012 (COM(2017) 604 final, 19.10.2017)