Half Time score on EU short selling regulation: Common sense 1, Poltical motives 1

Pardon for this uncharacteristically jargon-heavy blog-post...

Following our event on the proposed EU regulation of short selling in March, we expressed our concerns that political motives were trumping common financial sense at that point in the negotiations (based on the European Parliament’s proposal). It looked as if certain EU politicans had got one over on the markets (or so the politicans would like to present it) with a proposed ban on uncovered credit default swaps (CDS) and extending a ban on naked short selling to the sovereign debt markets.

Now, having examined the latest proposal to come out of the recent meeting of EU finance ministers, its looks as if the common sense is slowly gaining some ground back.

For starters, they’ve left CDS largely alone, apart from a clause which allows CDS activities to be temporarily banned in exceptional circumstances if all national regulators agree (which gives the FSA an effective veto).

The proposal still bans naked short selling (as it was ultimately designed to do), including sovereign debt, but this can be rescinded if it is seen to harm liquidity in sovereign debt markets. Interestingly, short selling of sovereign debt is allowed if it is seen as hedging against a corresponding long position. The European Securities Market Authority (ESMA) is mostly given a coordination role, it can attempt to rescind or extend the ban on an EU-wide basis but, again, it requires the consent of national authorities to do so.

The transparency rules are still included, stating that any investor with a significant net short position in shares must disclose it to regulators and to the markets if above a certain threshold. Importantly, this has been watered down in reference to sovereign debt so that no public disclosure is necessary. Public disclosure of short positions isn't uncomplicated but ultimately its impact will depend on the exact threshold levels and the format in which it is disclosed, both details which are yet to be announced.

Clearly, the Council's proposal is better than what some countries, such as France, had pushed for, particularly in relation to sovereign debt. It looks as if, at least in this round of the negotiations, the common sense approach - not least in terms of avoiding cutting off sources of liquidity for struggling eurozone countries - has been taken to heart. However, the negotiations are far from over, with the European Parliament still pushing for its far tougher proposal.

Member states and MEPs will now have to try to find a compromise between their respective proposals (with some member states no doubt using those negotiations trying to win back concessions that they horse-traded away - that's the nature of co-decision and Qualified Majority Voting).

So while this is pretty good news, it's only the half-time score.