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Ban on short selling

The Dutch Authority for the Financial Markets (AFM) announced on September 21 2008 a prohibition on short selling, as well as a request to disclose certain short positions to the AFM with regard to specific financial undertakings. Initially, only naked short selling was prohibited. As of October 5 2008, covered short selling also became subject to this ban.

The ban took the market by surprise. Although regulators in the US, the UK and Australia had taken similar measures against short selling, in August the Dutch Minister of Finance took a clear position against a curb on short selling in response to questions in parliament. Also, the AFM had not consulted market parties before announcing its measures, though it is under a statutory obligation to do so. Finally, in the financial newspapers, lawyers questioned whether the AFM had adequate legal powers to introduce a ban on short selling and a disclosure obligation relating to net short positions.

On October 11 2008, the Act on Financial Supervision was amended. The law now explicitly provides that the AFM may decide that certain types of transactions or trade orders are deemed to fall within the scope of the prohibition on market manipulation. The AFM's ban on short selling has been based on this new provision since that date. Consequently, violating the ban on short selling may not only lead to enforcement measures by the AFM: it also constitutes market manipulation, which qualifies as a criminal offence.

An entity that enters into a transaction or places a trading order that, either by itself or in combination with other transactions or trading orders, creates or increases a net short position falls within the scope of the prohibition. The prohibition relates to the following eight financial undertakings: AEGON NV, ING Groep NV, Fortis NV, BinckBank NV, KAS Bank NV, SNS REAAL NV, Van der Moolen Holding NV and Van Lanschot NV. A net short position refers to any economic exposure through any instrument (including contracts for differences and options), whether direct or indirect, to the total issued share capital of a company. The ban on creating and increasing a net short position implies that a short position can be offset against a long position of the same size relating to the same company. However, issuers of convertible bonds are not considered to be short selling under these provisions. Over-the-counter (OTC) transactions do fall within the scope of the prohibition, whereas credit default swaps do not. The AFM says that it does not impose restrictions on stock lending activities. At the same time, the AFM urges pension funds and other stock lenders to alert them if they suspect that stock is being borrowed for the purpose of prohibited short selling.

The prohibition does not apply to market makers. A market maker is defined as an entity that constantly shows a willingness in the financial markets to deal as principal by buying or selling financial instruments at prices it sets, both in the OTC segment and in the regulated markets or multilateral trade facilities, in a manner that usually ensures that on a constant basis liquidity is created in the markets, on the understanding that this must apply both to the bid and offer sides.

Every entity that has or acquires a net short position of 0.25% is subject to an obligation to notify this short position to the AFM. In this respect every form of economic interest related to the total issued capital of one of the relevant financial undertakings has to be taken into consideration, again excluding an economic interest that is held in the capacity of market maker. Although net short positions held at the end of the day need to be disclosed, the short selling requirements do not allow persons to actively increase their net short position intra-day. Disclosure should be made at group level and needs to be specified at group level, provided that the disclosure clearly states which position belongs to which entity. Although each legal entity is allowed to disclose on behalf of the group, all the positions within the group must be aggregated.

With respect to investment management, the AFM makes a distinction between non-discretionary management, managers with a discretionary mandate, funds and managers thereof. In the case of non-discretionary management, the short selling prohibition, as well as the disclosure obligation, applies to the client. If the manager has a discretionary mandate relating to segregated accounts, the short selling prohibition applies to the client. Where an investment manager manages collective investment schemes on a discretionary basis, the prohibition applies at the fund level. Where the fund in question is an umbrella fund with a number of sub-funds, the prohibition applies at the sub-fund level. In respect of discretionary asset management and funds, the disclosure obligation applies both at the level of the client/fund and the manager. The manager will have to disclose its aggregate net short position.

The AFM has recently decided to extend the duration of the short selling measures until January 17 2009. It is unclear whether the AFM will extend the duration any further, as the AFM's board has publicly questioned whether the measures help to decrease the volatility in the markets.

Hugo Oppelaar and Jan-Willem de Jong

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