The European Union's executive unveiled a blueprint on Wednesday to curb or ban short-selling and tighten controls on derivatives in one of its most ambitious financial reforms since the economic crisis unfolded. The shake-up tackles two of the most opaque parts of financial services, seen by many politicians as the hunting ground for speculators seeking quick profits.
It gives unprecedented powers to a new pan-European agency to impose 3-month bans on short-selling - the sale of a security the seller does not have, often betting that the stock price will fall. The two laws, set to come into force in 2012, also lay the foundation for the overhaul of the $600-trillion-plus derivatives market as well as imposing strict curbs on "naked" short selling.
"No financial market can afford to remain a Wild West territory," said Michel Barnier, the EU commissioner in charge of financial services reform. "We have to limit risks of hyper-speculation." Derivatives, once described by billionaire investor Warren Buffett as "financial weapons of mass destruction", were blamed for triggering panic after the collapse of Lehman Brothers two years ago while some politicians say short-selling exacerbated Greece's problems as it grappled with heavy debt. The Association for Financial Markets in Europe (AFME), which represent the major banks, said most derivatives were bespoke for specific users to hedge risks and that insisting on central clearing may "introduce disproportionate costs".
OUT IN THE OPEN The new laws, if agreed by the European Parliament and the bloc's 27 countries, will demand that short trades in the market be flagged to regulators. Large short positions - over 0.5 percent of a company's market value would be made public.
It will give policing powers to the European Securities and Markets Authority - due to open in January 2011 - allowing it to stop short selling or prevent maverick countries imposing their own bans as Germany did earlier this year. There will also be strict curbs that come close to a ban on naked short-selling, when sellers have not arranged to borrow the assets such as a company share they promised to sell.
Under the Commission's proposals, which are tougher than Washington's code, regulators will be able to demand a "naked" seller show how he intends to complete the deal. This means that to enter a short sale, an investor must have borrowed the instruments already or have a commitment to do so.
Differences between new European Union and US rules to crackdown on derivatives will be a key test of how well transatlantic regulators can co-ordinate to iron out loopholes banks may be tempted to exploit. The new rules will also usher in strict controls of derivatives, whose value is linked to the price of a financial instrument such as a company share or commodity such as oil.
The Commission wants better identification of trades in this market, where many multi-million-euro deals are recorded only by a fax between seller and buyer. The proposals make it mandatory to report all trading to central data banks, something Barnier compared to a "black box", that regulators can use to keep tabs on the market. It will also ask derivative traders to use clearing houses which provide a safety net in the event of a collapse like Lehman, by stepping in should either buyer or seller to a trade go bust. The drive for transparency is likely to challenge the dominance of the roughly half a dozen large banks that run the market now, where trades mostly take place over-the-counter or off-exchange.
These banks, which include Deutsche Bank, Barclays, Goldman Sachs, J.P. Morgan, Bank of America and Citigroup, design derivatives for customers and trade them among themselves. Some industry lobbyists were critical of the plans for short selling curbs. The International Securities Lending Association, a group including pension funds who lend securities to short sellers, warned it would push up costs for investors.
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