Saturday, 28 May 2011

Short selling regulation?

While the European Parliament works on funny videos that declare its resolution to fight against the financial crisis (see earlier post), the Economic and Financial Affairs Council agreed on a general approach on a draft Regulation on short selling and certain aspects of credit default swaps (on the 17th of May). This means that serious negotiations on this Regulation may now start with the European Parliament (and it will get its chance to make good on his resolution).

Short selling is one of the financial instruments that tend to be misleading and misunderstood by consumers. It basically allows consumers to sell a security that they do not own, but that is promised to be delivered, with the intention of buying it back later. What's the point of this practice? If the security price drops between the time the consumers short sell it and buy it back, the consumers make a profit from that price difference. Short selling is common for share trading but it can also be used for other financial instruments, e.g. government bonds. There are also two types of short selling: covered and uncovered (or naked - where at the time of the short sale the consumer has not borrowed the securities).

The European Regulation on short selling is something that is definitely missing in order to harmonize financial markets within Europe. It would guarantee common transparency rules (e.g. need to disclose net short positions either to regulator or, at a higher threshold, to the market) and would harmonize powers that regulators may use in exceptional situations, e.g. where there is a serious threat to financial stability (e.g. temporary powers to require more transparency or to restrict short selling transactions). Moreover, naked short selling (the more risky type) would be forbidden (with exception for short selling of sovereign debt).

Press release may be found here.

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