Trouble Ahead? New Short Selling Regulations from ESMA

Posted by  on  Aug 27, 2012

The first half of this year has seen a flurry of activity among regulators as they battle to construct new regulatory regimes that reduce risk, increase efficiency and bring a new level of transparency to volatile markets. Driving this volatility is a series of unknowns, ranging from the longevity and stability of the euro to which country will be next to require a bailout.

I recently attended the annual International Securities Lending Association (ISLA) conference in Madrid, where one of the subjects up for debate was, of course, regulation. Based on the keynote, it seems very clear that increased regulation is coming, whether the industry wants it or not, and it’s coming soon. The keynote opinion stated that the political glue that holds Europe and the single currency together may be more like concrete, and the solution for Europe could be, in fact, “more Europe.”

The new SSR legislation is a prime example of this in the context of the securities lending industry. While its primary aims are to increase market settlement certainty and reduce naked short selling, the original drafts included many potentially serious unintended consequences for securities lending, and by association, the wider financial market itself through reduced liquidity, wider spreads and poorer price discovery. Thankfully, much of this has been avoided through effective use of the short consultation period available, but in the run up to implementation of the new rules in November this year we face a new problem – that of interpretation and application.

At the conference, I co-chaired a well-attended roundtable on SSR. Two aspects of that session raised concerns that are worth further debate. In a room of more than 30 people, there was only one agent lender. He agreed with two senior representatives of two large borrowers present that the lending community were generally taking little action responding to the new SSR regulations, instead expecting their borrower counterparts to create a new one-size-fits-all liquidity measuring and locate recording process for them. While this may sound like a good idea, the two major borrowers then explained that they had totally opposing positions in interpreting the regulations, so how they were going to apply them?

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