Short-selling regulation (“SSR”) is a key aspect of financial market oversight aimed at promoting fair trading practices and ensuring market stability. Short selling has been regulated in the United Kingdom since 2012 as part of the regulatory reforms introduced by the European Union in response to the 2008/09 financial crisis. Post-Brexit these regulations were converted into domestic law as amended by the ‘Short Selling (Amendment) (EU Exit) Regulations 2018’ following the end of the transition period. The SSR provides a framework that balances strategic investment opportunities with the need for stability.
What is Short Selling?
Short selling is an investment strategy where investors, including institutions and individuals, sell financial instruments such as shares, sovereign and corporate bonds, or Exchange Traded Funds (ETFs) listed on UK trading venues. The goal is to profit from a potential decline in the asset’s price. For instance, an investor borrows shares from a lender and sells them at the current market price. If the price of the shares falls, the investor can repurchase them at a lower price and return them to the lender, pocketing the difference as profit. However, if the price rises instead, the investor incurs a loss when repurchasing the shares.
This strategy is inherently high-risk and typically used by investors who are confident in their experience and market analysis.
Whilst profitable, short selling can destabilise markets. Large-scale shorting can sharply reduce asset prices, triggering market volatility and crises. A notable example of a “short selling crisis” is the 2008 financial crisis, where short selling played a role in the collapse of financial institutions and the housing market. In this case, short-sellers targeted major banks and mortgage-backed securities, further accelerating the financial crisis. These events, amongst others, highlighted the importance of regulating this practice.
Key Provisions of the SSR
The SSR ensures short selling is transparent and controlled, minimising risks to market stability with:
- Transparency Requirements – Investors must disclose significant short positions to the FCA, and large enough positions must also be made public. This dual-reporting system promotes transparency and keeps regulators informed with investor practices.
- Restrictions on Uncovered Short Selling – “Uncovered” short selling, where shares are sold without being borrowed or secured, possess significant risks. The SSR requires investors to borrow shares in advance or ensure they can cover the sale, preventing speculative activities that could destabilise markets.
- FCA Emergency Powers: – The FCA can impose temporary restrictions on short selling during periods of market stress. If a financial instrument’s price drops significantly, these measures help prevent further declines and significant market impact.
- Market Maker Exemptions – Market maker firms, who provide liquidity by continuously buying and selling securities, are granted exemptions from some SSR restrictions. These exemptions ensure they can operate effectively, maintaining market efficiency and liquidity. An exemption example is the transparency requirement, which allows market maker firms to not disclose short positions as other investors. This is to prevent revealing their trading strategies, which could impact their ability to maintain liquidity in the market.
Role of the Market Abuse Regulation (“MAR”)
The MAR, adapted from EU rules and on-shored into UK law on 31 December 2020 by the ‘European Union (Withdrawal) Act 2018’, complements the SSR by targeting market manipulation. It prohibits spreading false information or manipulating trades to create artificial price levels. While the SSR focuses on transparency, MAR safeguards market integrity, ensuring ethical trading practices. These two frameworks form a robust regulatory defence line for companies to implement.
The Importance of Regulation and FCA Compliance Oversight FCA
The FCA enforces both the SSR and MAR by monitoring compliance and intervening during periods of significant market volatility where necessary. Firms involved in short selling must adhere to reporting requirements and avoid manipulative practices. The FCA maintains investor confidence and market stability by imposing restrictions when necessary.
The most recent enforcement action of MAR and trading regulations by the FCA that resulted in a fine (£123,500), were against a former Wizz Air executive in November 2024, who sold the said company’s shares during the company’s closed trading periods, and thus breaching Article 19(11) of the MAR and failing to disclose his personal trades to the FCA.
Subsequently, short-selling regulation balances profitability with systemic safety. It allows investors to capitalise on strategies without compromising market stability. The SSR and MAR foster a resilient regulatory framework by ensuring transparency and ethical practices. Compliance with these rules is not just a legal obligation but a commitment to fair market participation.
In summary, SSR protects markets by balancing opportunities with safeguards. This means allowing investors to take advantage of profitable strategies, such as short selling, whilst ensuring these activities do not destabilise the market or encourage manipulative behaviour. The SSR controls the technical aspects of short selling, whilst MAR enforces ethical standards. Together, they enable the FCA to maintain a transparent, stable and fair UK financial market.
How Can Complyport Help?
As experienced regulatory consultants, Complyport can assist firms in understanding their short-selling regulatory expectations and offer support to remain compliant with them. We offer tailored support to ensure firms navigate the complexities of the regulatory environment.
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