1 REPORT ON TRANSPARENCY OF SHORT SELLING Report of the Technical Committee of the International Organization of Securities Commissions June 2003 2 Background and mandate Short selling, broadly defined as the sale of securities that the seller does not own (see page 3), has long been a practice on which there have been sharply differing views. Some consider it a practice that adds to market efficiency; others see it as a practice that benefits markets but which also calls for controls; yet others consider that, on balance, it is a practice more likely to damage markets than enhance them. As a result, different jurisdictions have developed different regulatory approaches to short selling. While all the jurisdictions of the IOSCO Technical Committee Standing Committee on the Regulation of Secondary Markets (‘SC2’) members1 permit short selling, about half regulate what may be sold short and/or the way in which short sales are conducted. Some jurisdictions also have arrangements to bring a degree of transparency to short sales. They consider it important that market users have as much information on current trading dynamics as possible. While IOSCO has not recommended full transparency of short sales, the IOSCO Objectives and Principles of Securities Regulation state that: ‘Disclosure of short sales and securities lending (or at least their reporting to the regulator) is a tool for the further reduction of risk.’2 In addition, the IOSCO Emerging Markets Committee (‘EMC’), in a discussion paper published in May 1997, concluded that: ‘In order to prevent short selling from potentially being used for manipulative purposes, regulators should provide as much transparency as possible by regularly disclosing to the public the level of short selling activity in the market, so that its effect can be anticipated and any resulting change in market condition can be fully understood. The information is also a useful input for market participants in making their trading decisions.’3 Since that report, there has been continuing evolution of trading strategies employing short selling. Through the recent bear market, there has also been renewed public concern in some countries over the role of short selling in exacerbating market declines and increasing short-term volatility. In light of this, the Technical Committee requested that SC2 prepare a report examining the role that greater transparency of short selling might play in securities markets and the forms such transparency might take. The report’s aim is to assist regulators in assessing: • the benefits and drawbacks attaching to transparency of short sales; • the ways in which transparency regimes can be structured and implemented; • any issues that might arise in respect of different transparency regimes being applied to short selling of the same instrument by different market operators and/or in different jurisdictions. Scope and structure of paper The Technical Committee recognises that the case for the regulation of short selling varies from jurisdiction to jurisdiction, depending on a range of domestic factors. This paper does not therefore offer views on whether short selling should, in general, be regulated. However, it does provide background on the role of short selling in today’s markets, on the risks that may arise to market 1 A list of SC2 members can be found at the end of this report. 2 IOSCO Objectives and Principles of Securities Regulation, 13.11.3, IOSCO Report, September 1998 3 Short Selling and Securities Lending: Issues for Consideration, IOSCO Emerging Markets Committee Report, May 1997 3orderliness and investor protection, and the principal tools currently used to mitigate those risks. This provides context to help regulators in considering the role that transparency of short selling might play in their markets. In particular, it may assist them in considering the potential usefulness of transparency as an incremental ‘tool’ in support of more direct controls, or as a stand-alone measure that they might wish to deploy in substitution for other measures. The rest of the paper is structured as follows: - I. Introduction A. Definition of short selling B. Market role and benefits of short selling C. Extent of short selling - II. General regulatory issues A. Regulatory concerns B. Regulatory approaches and tools - III. Transparency issues A. Potential benefits of transparency B. Potential drawbacks of transparency C. Symmetry between long and short disclosure D. Transparency to regulators - IV. Implementation issues when introducing a transparency regime - V. Conclusions and recommendations In addition, appen