Banks and industry bodies have criticised the European
Securities and Markets Authority’s
(Esma’s) draft rules on short-selling and credit
default swaps, with UBS and Deutsche Bank singling out the
draft locate arrangements as an area of key concern.
"Using the definition for liquid share of the Markets in
Financial Instruments Directive (Mifid) is inappropriate as
it is used to determine if a quoting obligation should
apply," said Andrew Proctor, Deutsche Bank’s
global head of government and regulatory affairs in the
bank’s comment letter. "It does not relate to
the availability of shares to put in place a borrowing
The proposed requirement to confirm the effective allocation
of shares by having a third party put illiquid shares on hold
will have a significant market impact, added Proctor.
It risks leading to a daily practice where a firm must ask a
third party for shares to be put on hold in case it wants to
make a short sale. At the end of the trading day, the firm
might not actually have taken the short position.
"As this would happen on a daily basis some illiquid shares
would be put on hold indefinitely, thus effectively taking
them out of circulation," said Proctor.
Four influential industry bodies also added their voices to
the debate, taking issue with the provision of exhaustive
lists of agreements, arrangements and third parties. The
Association for Financial Markets in Europe, the
International Capital Market Association, the International
Securities Lending Association and the International Swaps
and Derivatives Association said the lists do not include
agreements or entities that are commonly used for covering of
The definition of third party should not preclude the use of
a specialist internal repo or securities lending desk, they
The City of London Law Society also disagreed with the use of
an exhaustive list, suggesting that if a list is included, it
should be a non-exhaustive list of examples only.
But according to the European Banking Federation, an
exhaustive list provides certainty and clarity to all market
participants. The authority did say that, to retain a degree
of flexibility, the lists should be reviewed and updated on a
Derivatives clearing house ICE Clear Europe suggested that
the regulation’s reference to entering into an
uncovered credit default swaps (CDS) should be narrowly
construed so that it only applies to voluntarily entered into
"If a narrow interpretation is not adopted, the prohibition
on uncovered CDS in the proposed regulation could have the
unintended effect of catching and restricting the activities
and default management practices of CCPs [central clearing
parties]," said Paul Swann, president and chief operating
officer of ICE Clear Europe.
ICE’s clearing rules include provisions that
allow it to allocate the positions of an insolvent clearing
member to other clearing members. If ICE needs to use this
procedure in relation to a position in sovereign CDS, it
would be without knowledge of transferee clearing
members’ underlying sovereign bond holdings.
"It is therefore possible that in requiring transferee
clearing members to fulfil their contractual obligation to
take on the position, or part of the position, ICE would
inadvertently be obliging them to assume an uncovered
position in sovereign CDS," said Swann.
If a narrow interpretation is not possible, ICE suggested
that the proposed regulation should exempt CCPs from Article
14, where positions in uncovered CDS are assumed for the
purpose of providing CCP services.
A number of comment letters referred to the limited timeframe
Esma was given to prepare and consult the industry on its
technical standards, warning that it impinge their quality.
The general consensus was that more time is needed to assess
how the proposed requirements would impact the market.
Other responses warned that the proposed interpretation of
the grandfathering rule could result in retrospective effects
of the ban on uncovered sovereign CDS, which risks
introducing legal uncertainty, increasing prices of the
sovereign CDS protection or significantly reducing its
availability and so increasing funding costs for the
sovereign and corporate debt markets.
Peter De Proft, director general of the European Fund and
Asset Management Association, said it was odd that Level 2
proposals will have been set out before the final text of the
regulation has officially entered into force.