It is important to recall that in 2010, at Germany and France request, the European Commission put forward a proposal for a regulation on short selling and certain aspects of Credit Default Swaps (CDS). This Regulation was adopted and entered into force in 2012.
It has harmonised requirements relating to short selling in the EU as well as the powers that regulators may use in exceptional situations, in case of serious threat to financial stability or market confidence. Moreover, it entails further transfer of powers from national regulators to the European Securities and Markets Authority (ESMA).
The Government could not support the Commission’s proposals on disclosure requirements and restrictions on naked short selling relating to sovereign debt as they are likely to have an adverse impact on sovereign bond markets as well as on a sovereign's cost of borrowing. The Government said, during the negotiations, that the Commission’s proposal “implies significant and unmet ongoing costs for both firms and individuals, trading venues and clearing houses in establishing the infrastructure necessary to meet its requirements.” The Government has therefore opposed to the proposal, as it would increase the costs for governments seeking to raise money to finance their debt. However, the proposal was subject to the ordinary legislative procedure with QMV required at the Council, and the UK could not water down it. Unfortunately, this is another example of the UK being outvoted on EU financial regulations.
Despite UK’s opposition, the Regulation agreed by the European Parliament and the Council addresses both short selling and CDS. A permanent ban on naked short selling of bonds and shares, and on so-called naked credit default swaps has been imposed within the EU. The prohibition of naked CDS on sovereign debt was a victory for the European Parliament but a blow to the UK.
Under the Regulation, in order to deal with concerns that CDS curbs could negatively affect the liquidity of sovereign debt markets, a competent authority (national regulators) may temporarily suspend the restrictions, and lift the ban, if they believe that it is harming their sovereign debt market. However, this possibility is very limited. National regulators are required to show their sovereign debt market is not functioning properly and that such restrictions could have “a negative impact on the sovereign credit default swap market, especially by increasing the cost of borrowing for sovereign issuers or affecting the sovereign issuer's ability to issue new debt.” The decision of the national regulators to temporarily suspend the restrictions has to be based on “objective elements”, which have to be based on indicators specified in the Regulation, such as “high or rising interest rate on the sovereign debt.” Moreover, the national regulators are required to notify ESMA, before suspending the restrictions, as well as other national regulators about their intentions and the “objective elements” on which the suspension is based. Then, within 24 hours, ESMA will issue an opinion on the intended suspension of the ban. Obviously, ESMA may approve or reject the opt out, but, it seems that ESMA’s opinions will not be biding. However, according to French MEP, Pascal Canfin, "ESMA won't have any power to impose its decision but there will be political pressure and there will be judicial pressure if the framework is not respected," The ban on naked CDS can be suspended for one year, renewable for further periods of up to 6 months.
Furthermore, national regulators may temporarily suspend, for a renewable 6 month period, the above-mentioned restrictions “where the liquidity of the sovereign debt falls below a pre-determined threshold.” The Commission in a delegated act decides this.
The Regulation also harmonises national financial regulators’ powers as well as the conditions and procedures to prohibit or restrict short selling activities and credit default swaps. Hence, in case of exceptional circumstances, when adverse developments constitute a serious threat to financial stability in a member State or the EU, national regulators have powers to restrict or ban short selling in any financial instrument, credit default swaps and other transactions, subject to coordination by ESMA. The national regulators’ powers of intervention relating to short selling and credit default swaps in exceptional situations are temporary. The Commission has adopted measures, through delegated acts, specifying criteria and factors to be taken into account by competent authorities and ESMA while deciding when an exceptional situation arises.
Member states’ competent authorities may impose a temporary restriction on short selling of a financial instrument, in case of a significant fall in the price of the instrument on a trading venue in a single day, until the end of the next trading day or up to a further two trading days. However, before imposing such measures, they are required to notify ESMA. ESMA will then inform the competent authorities of the other member states whose trading venues trade the same instrument, so that they can apply the same measures. If national regulators disagreed over this matter and cannot reach an agreement, ESMA has legally biding mediation powers to settle such dispute. Hence, ESMA may take a decision requiring national regulators to take specific action or to refrain from action, “with binding effects for the competent authorities concerned, in order to ensure compliance with Union law.” It would, therefore, override, in this way, national regulators’ decisions.
ESMA will “perform a facilitation and coordination role in relation to measures taken by competent authorities” in exceptional situations. Moreover, member states’ competent authorities must notify ESMA of the measures they intend to introduce within one day. Then, ESMA, within 24 hours, will issue an opinion stating whether the proposed measure is suitable to address the threat and whether the duration of the measures is justified. ESMA might also consider that other competent authorities should take such measures. If a national regulator decides to take measures contrary to an ESMA’s opinion it would be required to fully justify its decision. Then, ESMA would consider whether to use its intervention powers. Such intervention powers are based on the ESMA’s regulation, which allows the agency to "temporarily prohibit or restrict certain financial activities that threaten the orderly functioning and integrity of financial markets."
The Regulation has also transferred national regulators’ powers to deal with emergency situations to ESMA, as regards financial instruments other than sovereign debt or sovereign CDS. ESMA has been empowered to require investors who have net short positions in relation to a specific financial instrument to notify a competent authority or to disclose such position details to the public. It may also forbid or impose conditions relating to investors from entering into a short sale or into transactions relating to financial instruments or limit the value of transactions in the financial instrument that may be entered into. Furthermore, ESMA has the power to take such measures if they are necessary to address a threat to the functioning of financial markets or the stability of the EU financial system, if the situation has cross border implications and if the competent authorities have not taken measures or the measures taken were not adequate to address the threat. ESMA is required to notify competent authorities of the measure it proposes. But, the proposed measures will take effect when ESMA publishes on its website notice of any decision to impose. ESMA is, therefore, empowered to adopt measures with direct effect, limiting or forbidding short selling. Thus, any measure adopted by ESMA will prevail over any previous measure taken by a national regulator. Hence, in the abovementioned situations, ESMA would be able to override measures taken by national regulators.
The UK has been demanding for ESMA’s powers to be limited. One could say that ESMA’s emergency powers to impose trading restrictions are illegal. It is important to recall that the ECJ has decided on the limits to the delegation of powers to agencies in the 1958 Meroni judgment (Meroni & Co., Industrie Metallurgiche, SpA v High Authority of the European Coal and Steel Community). The Court set up a general principle “A delegating authority cannot confer upon the authority receiving the delegation powers different from those which it has itself received under the Treaty.” According to the Court the discretionary delegation of powers to bodies, which are not foreseen in the treaty, would imply a wide margin of appreciation, replacing “the choices of the delegator by the choices of the delegate”, entailing, in this way, “an actual transfer of responsibility”, which would infringe the ‘principle of institutional balance.’ The Government noted that the proposed provisions conferring on ESMA the power to temporarily prohibit or restrict certain financial activities, entails a “wide discretion.” According to the European Scrutiny Committee “there is a significant risk that Article 28 is unlawful in that it delegates too much power to the European Securities and Markets Authority, in breach of the Meroni principle.”
The Government recent decision to launch a judicial challenge to the Short Selling Regulation on the grounds that it confers too much discretionary power on the European Securities and Markets Authority is threfore welcome.
According to the Daily Telegraph, the barrister representing the Government in this challenge, Jemima Stratford QC, said "There is a short point at the heart of this case. It is that the extensive discretion given to Esma is contrary to the institutional balance laid down in the treaties,". She noted that Esma’s powers would impinge on sovereignty over national economic policy.
The Government is particularly challenging Article 28 of the Regulation whereby ESMA has been granted intervention powers in exceptional circumstances. As above-mentioned, ESMA has the power to forbid or impose conditions on the entry by persons into short sales or to require them to disclose such positions if the transactions have been considered a threat to the functioning and integrity of the financial markets, or to financial stability with cross-border implications.
The Government believes that such provision is unlawful since the criteria it provides for ESMA to take action involve great discretion. The Government is also arguing that under Article 28, ESMA is allowed to impose measures of general application and to adopt non-legislative acts of general application, while under the EU Treaties the Council has no competence to delegate such powers to an agency.
