Short selling is a sensitive topic. Setting aside moral concerns about selling something one does not own, short sellers can provide convenient targets of criticism as the practice allows investors to profit when the share price falls. During the recent global financial crisis, the price collapse of listed financial securities following the demise of Lehman Brothers brought short selling onto the centre stage. Especially due to pressure from politicians, the press, and the public, regulators imposed temporary short selling bans worldwide in an effort to halt the downward spiral in prices. Short selling then returned to the spotlight during the subsequent sovereign debt crisis. In particular, as the Greek government showed signs of financial collapse, short sales and credit default swaps (‘CDSs’) on Greek sovereign debt increased, and certain Member States blamed short sellers for aggravating Greece’s financial woes. More recently, as China’s stock market experienced dramatic declines during 2015 and early 2016, the Chinese regulators pointed the finger of blame at ‘malicious’ short sellers (amongst others); imposed a variety of short selling restrictions; and instigated a number of market manipulation probes. Likewise, Greek regulators imposed a further set of temporary short selling bans during 2015 when Greece again teetered on the brink of collapse.
Following the financial crisis, short selling regulation did not form a key priority on the international G20 reform agenda. Nevertheless, in the US (a jurisdiction that had regulated short selling in one form or another since the 1930s), the Securities and Exchange Commission ( ‘SEC’) subsequently implemented a number of new short selling restrictions with respect to equity securities, including re-introducing a type of short sale price test. In the EU (where many jurisdictions had historically never regulated the practice), the Short Selling Regulation (the ‘Regulation’) was implemented in 2012, largely as a consequence of the sovereign debt crisis. Indeed, the influence of the debt crisis is evident in the Regulation’s provisions that not only cover the short selling of equity securities, but also restrict short selling in the sovereign debt markets. Notably, the Regulation also confers a wide set of supervisory powers on the European Securities and Markets Authority (‘ESMA’). In contrast to the powers granted to its predecessor, the Committee of European Securities Regulators (‘CESR’), ESMA has far-reaching operational powers under the Regulation, and its powers also enable it to directly intervene with respect to short selling in exceptional circumstances. ESMA’s powers considerably extend its authority beyond that granted to CESR, and illustrate a major step forward with respect to EU intervention in markets.
The purpose of this article is to analyse the regulatory choices that have been made with respect to short sale restrictions in the EU and the US. It analyses the permanent and temporary short selling constraints now in place on both sides of the Atlantic Specifically, it demonstrates that, although some functional similarities are evident, divergences also exist, not least in the absence of restrictions on the short selling of sovereign debt in the US. Further, aside from the EU’s regulation of the sovereign debt markets, the short selling restrictions in place in the US are, in fact, more onerous than those in the EU. The article suggests that this outcome can, perhaps, be explained in part by political pressures brought to bear on the SEC following the crisis. First, the SEC is required to go ‘cap in hand’ to Congress for its funding on an annual basis; further, the SEC was also considerably weakened as a regulatory body following the financial crisis. Consequently, in terms of the future direction of its short selling policy, it may well have been partly seeking to placate its political critics in order to maintain its jurisdiction going forward. Turning to the EU, although the legislative passage of the Regulation was also a highly politicised affair, some of the more interventionist proposals could be ultimately watered down during the Regulation’s lengthy negotiation process.
Elizabeth Howell is the Slaughter and May Lecturer in Corporate Law in the Faculty of Law at the University of Cambridge, and a Fellow of Magdalene College.