EU Proposals Target Short Selling (After raising GDP forecasts)
BRUSSELS—New European Union proposals emerged Wednesday, aimed at regulating financial practices that were blamed for intensifying the global financial crisis, including the short selling of securities.
The European Commission, the EU's executive arm, proposed regulations for short selling, the sale of borrowed securities by an investor who hopes to make a profit by buying an equal number of shares at a lower price to replace the borrowed securities. The proposals also cover credit-default swaps and the clearing and greater standardization of over-the-counter derivatives.
EU Commissioner Michel Barnier gave a news conference on derivatives, credit default swaps and short selling at the European Commission headquarters in Brussels.
.One proposal would require most derivatives trades to be routed through centralized clearing houses, which are entities that ensure companies can cover their losses if their trades go awry. The other would force investors to disclose more information about the bets they make against companies or the debt of governments, with European regulators given the power to ban these trades temporarily in a period of market turmoil.
Both pieces of legislation give the European Securities and Markets Authority, one of the EU's newly created financial regulators, broad authority to regulate the financial-services industry.
Officials said the legislation would increase the convergence of the EU's framework of financial regulation with those of the U.S. and Hong Kong.
The legislation would, if adopted, force investors to disclose short positions to regulators if they exceed 0.2% of a company's issued share capital. They would require disclosure to the rest of the market if the short position exceeds 0.5%. Each short sale would also have to be flagged to regulators.
The commission wants to ensure that national decisions to restrict or ban short-selling are coordinated at a European level, after Germany roiled markets earlier this year when it banned short-selling the debt of euro-zone countries and some financial institutions.
Together with other proposals due in coming months that will affect derivatives trading and capital requirements for traders, the EU's legislation is meant to encourage a greater standardization of derivatives and to ensure that as many transactions as possible pass through centralized counterparties, or CCPs. CCPs act as the buyer in every sale and the seller in every purchase.
Each CCP would decide which contracts it wishes to clear, and would require the go-ahead to do so by a national authority. Additionally, the recently created ESMA would be able to mandate which contracts should be cleared across the EU.
The aim is to allow regulators a better view of trading in the over-the-counter derivatives market and avoid a build-up of risks like the one that destabilized the financial system following the collapse of Lehman Brothers in 2008.
The clearing requirements proposed in the legislation will probably make derivatives trading more expensive for the large financial firms that dominate the market.
But the rules won't apply to all companies. Airlines, energy producers and other non-financial firms will receive broad regulatory exemptions, after successfully arguing to the commission that they shouldn't be penalized for using derivatives to hedge risks posed by fluctuations in commodity prices, currencies and interest rates. Nonfinancial companies would in principle not be subject to the requirements unless their positions "reach a threshold and are considered to be systemically important."
The commission's proposal wouldn't place limits on whether banks or other institutions can also own stakes in clearing houses, even as they will be required to have independent boards and other governance arrangements. Some lawmakers in the U.S. and the EU have called for limits on financial institutions also owning clearing houses to prevent conflicts of interest between clearing houses and their members.
The derivatives market, worth hundreds of trillions of dollars, remains largely unregulated two years after the giant U.S. insurer American International Group Inc. nearly collapsed under the weight of derivatives contracts it wrote to insure hundreds of billions of dollars worth of risky debt. The U.S. government nationalized the company and agreed to stand behind its enormous book of derivatives trades to prevent a default that could have destabilized AIG's trading partners, many of which are important financial institutions.
That episode, along with the collapse of Lehman Brothers, a major derivatives trader, pushed governments around the world to decide that companies should be forced to use derivatives more conservatively.
A draft of the proposed legislation described the measures as "consistent with the recently adopted U.S. legislation on OTC derivatives, the so-called Frank-Dodd Act."
The proposals will be amended during separate discussions among European governments and in the European Parliament. Differences that emerge between the two versions will be resolved with the help of the commission.
The short-selling regulations are expected to be in place by July 1, 2012, and the derivatives rules by the end of 2012.
—Matthew Dalton contributed to this article.
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