THE UK’S LIGHTER-TOUCH, POST-BREXIT, SHORT SELLING REGIME

Draft legislation published. Next up: proposed regulatory rules

The U.K. is currently engaged in a wide-ranging review of the inherited package of EU financial services law. The rules on short selling, which impose disclosure obligations and restrictions on persons seeking an economic position that means they benefit in the event of a fall in the prices of a certain security, have been a priority. In principle, such rules are a constraint on free markets, since participants would otherwise be able to invest based on the possibility of prices going up or down. Following various periods of market volatility, there has been a political imperative on the part of the EU to do something about ‘speculators’ and other investors who make money out of price falls. For example, when there was significant shorting of the debt securities of several EU member states in the late 2000s and early 2010s by certain investors, and such investors were seen as profiting from the misfortune of EU governments. There is also a longstanding regulatory concern about short-selling strategies being used for market abuse purposes, e.g., a market squeeze, which are largely addressed under the Market Abuse Regulation^[1]. With this background, the EU introduced the Short Selling Regulation (“EU SSR”)^[2] in 2012. The EU SSR established very low (starting at 0.1%) public reporting thresholds for any person taking a short position on shares admitted to trading on an EU exchange or multilateral trading facility (MTF) or EU sovereign debt or credit default swaps (CDS). It also established a ‘cover’ requirement, meaning that those taking a short position must locate and reserve actual securities for later delivery while they hold that position.

The EU SSR was onshored in the U.K. following Brexit. However, the regime as a whole has always stood in contrast to the U.K.'s more free markets approach, and has become a focus for post-Brexit reform. Prior to the EU measure being introduced, the U.K. had only ever introduced short selling measures for shares to address perceived disorderly speculation in particular cases or sectors at the start of the 2008 financial crisis. The U.K. is now introducing a targeted liberalization of the inherited EU regime and has now taken another step closer to implementing that regime with the publication of the draft Short Selling Regulations 2024 (“draft SSR 2024”)^[3]. This client note discusses the details of the U.K.’s incoming revised short selling regime.

HM Treasury’s draft legislation sets the scope of the revised regime and empowers the Financial Conduct Authority (FCA) to make the detailed firm-facing rules. With many of the details moving from the existing legislation to the FCA’s rules, the U.K.’s regime is set to become far nimbler than the EU system, where changes must be effected by amending primary legislation. Furthermore, some aspects of the regime are being removed entirely, most notably the short selling regime for sovereign debt and CDS, which will no longer apply to U.K. government-issued instruments (unless an emergency measure is introduced by the FCA).

HM Treasury intends to lay the full draft SSR 2024 before Parliament in 2024. The draft SSR 2024 will enter into force at the same time that the existing U.K. Short Selling Regulation (U.K. SSR) is repealed and will coincide with the date from which the FCA’s new rules apply. The FCA is due to consult in 2024 (possibly in Q1 2024) on its proposed approach and new rules. No further indication is provided on timing for the effective date of the new regime. For the time being, firms should continue with their normal short position calculations and filings, since the new regime will not become effective until the FCA's rules come into force. This is a notable and more libertarian departure from the EU’s regime.

Scope

Short selling is one of the activities stipulated in the Financial Services and Markets Act 2023 as falling into the new designated activities regime (DAR). This means that short selling will fall under the FCA’s remit when conducted by any person, regardless of whether they are regulated by the FCA.

The draft SSR 2024 provides that the designated activity of short selling involves either:

• Entering into a short sale of a share.
• Entering into a transaction which creates or relates to a financial instrument other than a share, where an effect of the transaction is to confer a financial advantage on the person entering into that transaction in the event of a decrease in the price or value of a share.

The scope of shares covered by the SSR 2024 is broader than that under the existing U.K. SSR. The new regime will capture all shares admitted to trading on a U.K. trading venue (i.e., a U.K. exchange or U.K. MTF), including when those shares are traded outside a U.K. venue. This differs from the existing regime which provides exemptions for shares admitted to a U.K. trading venue that are principally traded on a venue outside the U.K. The FCA will be empowered to exempt certain shares from the rules under the incoming regime (discussed further below).

The draft SSR 2024 does not reproduce the EU onshored requirements for short positions in sovereign debt or sovereign CDS, including the related reporting requirements. The U.K. is revoking the short-selling regime for these instruments, for business-as-usual reporting^[4]. This is a significant departure from the EU’s regime and is intended to support the U.K. government’s policy to promote the competitiveness of the U.K. markets. Sovereign debt and sovereign CDS will, however, be in scope of the FCA’s emergency powers, which are discussed below.

Separate legislation will implement the DAR, including supervision and enforcement provisions that will apply across all designated activities, including short selling. Therefore, those sorts of provisions are not included in the draft SSR 2024.

Restrictions on Uncovered Short Sales in Shares

The FCA is empowered to make designated activity rules, including but not limited to rules restricting the entering into uncovered short positions in shares unless the person takes steps to ensure the settlement of a short sale transaction can be effected when due. These restrictions are currently set out in the existing U.K. SSR and include, for example, requirements to borrow the share or to enter an agreement to borrow it, and the requirements on locating the share. Under the revised U.K. regime, these restrictions will be consolidated into one place in the FCA Handbook. This contrasts with the existing regime, which mirrors the EU approach of having the main requirement in the EU SSR and the details in technical standards.

Reporting Obligation – and its Threshold

The draft SSR 2024 provides that the FCA may make rules requiring persons with a net short position in the issued share capital of a company to notify the FCA when that position reaches the notification threshold, which is set at 0.2%. HM Treasury recently provided for the current notification threshold in the U.K. SSR to increase from 0.1% to 0.2% from February 5, 2024. This provides increased certainty for market participants while the new regime is being implemented. HM Treasury will be able to adjust the notification threshold in future statutory instruments.

The draft SSR 2024 does not include a requirement to notify the FCA at each 0.1 % (or 0.2%) above the notification threshold, as is the case in the EU SSR. Such a requirement, and rules on updating disclosures as holdings change, seem likely to be specified by the FCA in its rules.

Exemptions

Potential Exemptions for Certain Shares

The FCA is given rule-making powers to introduce exemptions to its designated activity rules for certain shares or classes of shares, including the reporting obligation and the restrictions on uncovered short sale positions. The FCA may use its powers to exclude shares that are principally traded on a trading venue outside the U.K.

Market-Making Exemption

The FCA may also make rules exempting transactions carried out for market-making or stabilization purposes. The FCA’s rules may supplement the draft SSR 2024 as to what constitutes market-making, and provide for those intending to use the market making exemption to notify the FCA. However, the draft SSR 2024 limits the availability of the market-making exemption to banks, investment firms and overseas entities that are members of a U.K. trading venue or of a market or trading venue in an overseas jurisdiction for which there has been an equivalence determination. The draft SSR 2024 does not at this stage include particulars about the regime applicable to overseas firms, but it is intended that the draft that is laid in Parliament will give HM Treasury the powers to make equivalence determinations and provide a transitional regime for the existing EEA equivalence determination.

Publication by FCA of Short-Selling Notifications

Where the FCA is notified of short positions held in a company, the draft SSR 2024 requires the FCA to publish the aggregate net short position for the issued share capital of a company for each working day that positions are held. The aggregation of positions is a change, which emerged in the feedback to HM Treasury’s consultation, from the current approach where the FCA publishes individual net short positions above 0.5% of issued share capital. The publication of aggregated data is being adopted in other jurisdictions. For example, in mid-October this year, the U.S. Securities and Exchange Commission adopted a new rule requiring institutional investment managers with short positions in equity securities over a certain threshold to report those positions to the SEC. The SEC will publish aggregated data based on those reports^[5].

The FCA is also required to publish and maintain a list of shares to which the short selling requirements apply. This list would exclude those shares for which there is any exemption under the FCA rules.

FCA Emergency Powers

The draft SSR 2024 grants the FCA emergency powers, such as the power to ban short sales or impose conditions on short sales, to limit short sales following a significant price fall in a financial instrument and to require notification of short positions and information on lending fees. The U.K. has previously introduced emergency short selling measures, including a temporary ban in 2008 on net short positions in U.K. banks and insurers^[6]. However, the FCA declined to follow its EU counterparts in implementing a prohibition in response to market conditions during the COVID-19 pandemic^[7].

The FCA’s emergency powers under the draft SSR 2024 apply to a wider range of financial instruments than the short selling designated activity regime discussed above, which only covers shares and related instruments. The financial instruments in scope of the emergency powers include debt instruments, money-market instruments, units in collective investment undertakings, derivatives, contracts for difference and emission allowances. Sovereign debt and CDS, excluded from the general short selling regime, will fall under these emergency powers. Certain conditions must be met before the FCA can use these emergency powers and the FCA must publish a notice of any decision to act upon the powers. In addition, the FCA must publish a new statement of policy describing how it intends to use these powers, and the FCA is expected to consult on its proposed approach.