The UK government has proposed changes to its rules governing short selling activity, which will potentially remove, or substantially revise, existing requirements relating to short positions in sovereign debt securities or sovereign credit default swap (CDS) contracts.
This announcement comes as part of a package of regulatory changes, collectively marketed by the UK government as the “Edinburgh Reforms”, which were announced on 9 December 2022 and designed to exploit the UK’s exit from the European Union to apply its own UK-tailored financial services legislation.
As part of this review, HM Treasury (HMT) has issued a call for evidence on the Short Selling Regulation (SSR), a regulatory package that was introduced by the EU and brought onto UK statute following its exit from the EU.
Subsequent to this call for evidence, HMT has now launched an additional public consultation around its proposal to abolish elements of the short selling rules relating to government debt and CDS, provisions that were not included in the initial call for evidence, as part of its plans to replace the SSR with a “UK tailored” regulatory regime.
In advancing these proposals, the UK government states that these provisions relating to sovereign debt and sovereign CDS are “an unnecessary part of the regulatory regime that does not achieve its policy objective that we have inherited from the EU”.
It says that it raised concerns about these elements of the SSR when this regulation was being negotiated in the EU on the grounds that this could have a negative impact on liquidity in UK sovereign debt markets.
It explains: “Based on evidence gathered to date, including engagement with the relevant regulatory authorities, the government proposes to entirely do away with the requirements placed on investors when taking out short positions in sovereign debt or sovereign CDS, and the related reporting requirements.” (parg 1.3)
In practice, these amendments will mean that the UK short selling regime will focus on short positions in equity securities, with sovereign debt and CDS continuing to fall under the Financial Conduct Authority’s emergency powers, dictating that the regulator can apply emergency short selling provisions under “exceptional circumstances” (parg 1.5).
In providing more detail, the UK government states that while it recognises a clear purpose in maintaining short-sale cover requirements for short positions in equities, “it is not necessarily the case” that the same requirements should apply to sovereign debt markets.
“While it is conceivable that in extreme circumstances, without covering requirements, short selling of shares in an individual issuer could exceed share availability, the government considers this risk to be almost non-existent in sovereign debt markets, given the size and liquidity of the market. It reports that, on 31 March 2022, the size of the UK gilt market was roughly £2.4 trillion larger than the market cap of all the FTSE 100 and FTSE 250 companies combined (parg 2.8).
The UK government also indicates that it does believe that the short-sale disclosure regime under SSR is working.
While the FCA receives approximately 3250 reports per month relating to equity short positions, the current reporting threshold for sovereign debt dictates that firms are “unlikely to take a short position big enough to be reportable”, the UK government claims.
“In practice, the FCA has received very few net short position reports on sovereign debt since the regime has been in place,” it adds. “Firms are required to implement extensive requirements on how to calculate a net short position in sovereign debt when the likelihood or usefulness of [this] reporting is very low in practice” (parg 2.9).
It notes that the regulatory authorities already receive detailed reporting on sovereign debt and CDS positions via reporting requirements under the Markets in Financial Instruments Regulation (MiFIR), the European Market Infrastructure Regulation (EMIR), the Securities Financing Transactions Regulation (SFTR) and through sterling money markets data.
HMT has pushed the proposal out for public consultation and has requested that interested stakeholders should return their feedback within four weeks.
