New short selling rules in the UK from 1 November 2012

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1 Ashurst September 2012 Briefing New short selling rules in the UK from 1 November 2012 On 1 November 2012, the UK's existing short selling disclosure regime (as set out in FINMAR 2) will be abolished when EU Regulation 236/2012 on short selling (the Short Selling Regulation) comes into force in the UK and in the rest of the EU. This briefing explains how the new rules for shares will work, using some practical examples (it does not cover those aspects of the Regulation which deal with sovereign debt and CDSs, for which see our client briefing: Naked CDS: the ban and beyond (March 2012)). Key points from the Short Selling Regulation: It requires notification to the UK Financial Services Authority (FSA) (or other relevant EU MiFID competent authority) where "net shorts" reach or fall below 0.2 per cent of issued share capital and each 0.1 per cent above that (Private Disclosure). It requires (in addition to Private Disclosure) public notification at the 0.5 per cent level and each 0.1 per cent above that (Public Disclosure). It prohibits short sales of shares unless the shares have been borrowed or are the subject of an enforceable claim or the subject of other specific arrangements defined and prescribed in the Regulation and related regulations. It has direct effect in EU member states; therefore the FSA proposes to delete the current provisions from FINMAR 2 (see CP 12/2) and there will be no equivalent new provisions. Notification must be made by 2 November of existing net short positions even if already notified under the UK's current regime. The new regime The existing UK rules only apply to companies undertaking rights issues or certain financial institutions whereas the new, wider, EU rules will apply from 1 November to all companies whose shares are admitted to trading on a regulated market or MTF as defined in MiFID. In relation to shares admitted to trading on a regulated market or MTF, the public and private disclosure rules cover net short positions on any market as well as off-market short positions, including derivatives, index related instruments, baskets and spread bets. Helpfully, one of the draft implementing regulations (see box 3) clarifies that shorts on financial instruments that give rise to a claim to unissued shares (e.g. nil paid rights, subunderwriting or placing (if the shares concerned are not then issued)), warrants and convertibles are not shorts for disclosure purposes. This is not the same as the rules governing the disclosure of long positions in Chapter 5 of the FSA's Disclosure and Transparency Rules, which, for example, would capture a purchase of nil paid rights. The prohibition on shorting shares similarly covers shorting shares on any market (as well as off-market) but does not catch derivatives. The UK currently has no short selling prohibitions, only disclosure rules. There are new rules for disclosure by groups and by portfolio and fund managers which are totally different from the existing UK rules. Key exemptions are for: Shares whose principal trading venue is outside the EU. ESMA will publish a list of these shares. Market making activities but notification must be made to the FSA that the market maker intends to use this exemption not less than 30 calendar days before it first intends to use it. Those who would like to use this exemption from 1 November will therefore need to submit their AUSTRALIA BELGIUM CHINA FRANCE GERMANY HONG KONG SAR INDONESIA (ASSOCIATED OFFICE) ITALY JAPAN PAPUA NEW GUINEA SINGAPORE SPAIN SWEDEN UNITED ARAB EMIRATES UNITED KINGDOM UNITED STATES OF AMERICA

2 notification by 1 October. The FSA has stated that it is its intention to publish the UK procedure for making such notifications, including the forms that the FSA will require to be completed, shortly after mid-september. This will leave little time for a market maker to finalise its notification and submit it to the FSA. ESMA has published guidance in its consultation paper on the market making exemption (ESMA 2012/580). Stabilisation within the UK rules. Worked examples We set out below some common situations which arise in everyday practice together with our provisional analysis of how they might be dealt with under Articles 5 and 6 of the Short Selling Regulation (disclosure) and under Article 12 of the Regulation (ban on short selling). It should be noted that the analysis gives, in a few cases, different outcomes from the current UK legislation. In the examples below, "Regulation" refers to the Short Selling Regulation and "Article" refers to the July Regulation (see box 1). Issuer issues convertible debt or subscription warrants No, it is not a net short position as it does not relate to the issued share capital (see Regulation 3.1(a)) and it does not confer a financial advantage on the issuer in the event of a decrease in the price of the shares (see Regulation 3.1(b)). Article 7(b) also makes clear that subscription rights shall not be considered as short positions when calculating a net short position (see box 3). No. A short sale is defined in Regulations 2 and 12 as "any sale of the share " and "any sale of the share admitted to trading on a trading venue" respectively and this is not a sale of the share. A person other than the issuer holds convertible bonds or subscription warrants representing five per cent of the share capital and sells short five per cent of the shares Yes, as the position in respect of the convertible bond or warrants is not a long position within Regulation 3.2(b) against which the short sale could be netted because of Article 7(b) as explained in Box 3, para 3 of ESMA's Final Report of 19 April 2012 (ESMA/2012/263) (ESMA Final Report) (see box 1 below). The holding of convertible bonds or warrants will permit the short sale under Regulation 12.1(b) and Article 5.1(e) of the Implementing Regulation but only if they can be unconditionally converted or subscribed in time for settlement under the short sale (because of the requirement in Article 5.1(e) that one must be entitled to receive the shares under the subscription rights on or before settlement of the short sale). An investment bank which has underwritten (or agreed to place) an issue of new shares lays off some of its risk by entering into a subunderwriting (or sub-placing) agreement with a fund manager No, it is not a net short position under Regulation 3(1)(b) because Article 7(b) states that short positions on financial instruments that give rise to a claim to unissued shares are not net short positions (see box 3). The sub-underwriting/placing is not a short sale and is therefore permitted because Regulation 12.1 only prohibits a short sale "of a share admitted to trading on a trading venue" and these shares are not yet issued. A third party (not the issuer) sells convertible debt or subscription warrants short No, it is not a net short position under Regulation 3(1)(b) because Article 7(b) states that short positions on financial instruments that give rise to a claim to unissued shares are not net short positions (see box 3). No. A short sale is defined in Regulations 2 and 12 as "any sale of the share " and "any sale of the share admitted to trading on a trading venue" respectively and this is not a sale of the share. Rights issues Consider three different scenarios: (1) the company does a rights issue and issues its shareholders with rights to subscribe for new shares (2) a shareholder sells rights short (3) a third party sells the shares short and buys rights. Are these disclosable net short positions? The analysis for disclosure purposes for each of the scenarios above is the same as under the first three examples above (relating to subscription warrants), replacing "subscription warrants" by "rights to subscribe".

3 Could these be prohibited short sales? The analysis for each of the scenarios above is the same as under the first three examples above in relation to subscription warrants. A person sells short a basket (or index or ETF) of shares, including shares in an issuer subject to the Short Selling Regulation Yes, this is a net short position (to the extent to which the underlying shares are represented in the basket, index or ETF), see Regulation 3.1(b) and Recital 10 which refers to "index-related instruments". It may also be necessary to disclose a net short of the shares in the ETF itself. Could these be prohibited short sales? Yes, if the basket, index or ETF is itself in the form of share capital admitted to trading in the EU but if the basket, index or ETF is in some other form further analysis would be required in relation to the structure and the underlying shares. A person enters into a bet with a betting company that the price of shares in an issuer will fall Yes, this is a net short position see Regulation 3.1(b) and Recital 10 to the Short Selling Regulation, which refers to trading outside trading venues and spread bets relating to shares. Article 7(b) (as interpreted in ESMA's Final Report). See box 3. Yes, as the underwriting/sub-underwriting/placing commitment is conditional and therefore does not meet the test set out in Regulation 12.1(b) (see box 2). A person enters into an option, future or CFD under which it will obtain an economic advantage, if the price of shares in an issuer subject to the Short Selling Regulation were to fall Yes see Regulation 3(1)(b). This is not a "short sale of a share admitted to trading" within Regulation 12.1 and is therefore not prohibited. However, the FSA has powers to prohibit short CFDs in exceptional circumstances and similarly the FSA has powers where prices have fallen significantly to prohibit any short sales even where the shares have been borrowed. Please speak to one of the Ashurst contacts listed if you require further information. No, this is not a short sale of a share admitted to trading on a trading venue within Regulation 12.1 and is therefore not prohibited. An investment bank sells short five per cent of shares of an issuer whose shares it has underwritten/sub-underwritten/agreed to take as a placee Yes, this is a net short position, because the underwriting/placing commitment does not count as a long position under Regulation 3.2(b) because of

4 Box 1 Background legislation and documents Regulation (EU) No. 236/2012 of the European Parliament and of the Council of 14 March 2012 on short selling and certain aspects of credit default swaps. Commission Delegated Regulation (EU) No. 826/2012 with regards to regulatory technical standards on notification and disclosure requirements. Commission Implementing Regulation (EU) No. 827/2012 covering the means for public disclosure of net position in shares etc. (Implementing Regulation) Commission Delegated Regulation (draft dated July 2012) covering the method to be used when calculating percentage decreases in the value of shares. Commission Delegated Regulation (draft dated July 2012) regarding definitions, calculation of net short positions etc. (July Regulation). ESMA final report of 20 April 2012 (ESMA/2012/263). ESMA Questions and Answers: Implementation of the Regulation on Short Selling and certain aspects of credit default swaps (ESMA/2012/572). ESMA consultation paper on the exemption for market making activities (ESMA 2012/580). Box 2 Useful extracts from the Short Selling Regulation Regulation 3.1 For the purposes of this Regulation, a position resulting from either of the following shall be considered to be a short position relating to issued share capital or issued sovereign debt: (a) a short sale of a share issued by a company or of a debt instrument issued by a sovereign issuer; (b) entering into a transaction which creates or relates to a financial instrument other than an instrument referred to in point (a) where the effect or one of the effects of the transactions is to confer a financial advantage in the event of a decrease in the price or value of the share or debt instrument. Regulation 12.1 Restrictions on uncovered short sales in shares 1. A natural or legal person may enter into a short sale of a share admitted to trading on a trading venue only where one of the following conditions is fulfilled: (a) the natural or legal person has borrowed the share or has made alternative provisions resulting in a similar legal effect; (b) the natural or legal person has entered into an agreement to borrow the share or has another absolutely enforceable claim under contract or property law to be transferred ownership of a corresponding number of securities of the same class so that settlement can be effected when it is due; (c) the natural or legal person has an arrangement with a third party under which that third party has confirmed that the share has been located and has taken measures vis-à-vis third parties necessary for the natural or legal person to have a reasonable expectation that settlement can be effected when it is due.

5 Box 3 Useful extracts from the draft Delegated Regulation Article 7 The following criteria shall be taken into account for the purposes of net short positions referred to in Articles 5 and 6: (a) It is irrelevant whether a cash settlement or physical delivery of underlying assets has been agreed. (b) Short positions on financial instruments that give rise to a claim to unissued shares, and subscription rights, convertible bonds and other comparable instruments shall not be considered as short positions when calculating a net short position. Key contacts Jeffrey Sultoon Partner T: +44 (0) E: Jonathan Haines Partner T: +44 (0) E: Nicholas Holmes Partner T: +44 (0) E: Richard Small Counsel T: +44 (0) E:

6 Abu Dhabi Suite 101, Tower C2 Al Bateen Towers Bainunah (34th) Street Al Bateen PO Box Abu Dhabi United Arab Emirates T: +971 (0) F: +971 (0) Adelaide Level Pirie Street Adelaide SA 5000 T: F: Brisbane Level 38, Riverside Centre 123 Eagle Street Brisbane QLD 4000 T: F: Brussels Avenue Louise Brussels Belgium T: +32 (0) F: +32 (0) Canberra Level Moore Street Canberra ACT 2601 T: F: Dubai Level 5, Gate Precinct Building 3 Dubai International Financial Centre PO Box Dubai United Arab Emirates T: +971 (0) F: +971 (0) Frankfurt OpernTurm Bockenheimer Landstraße Frankfurt am Main Germany T: +49 (0) F: +49 (0) Hong Kong 11/F, Jardine House 1 Connaught Place Central Hong Kong T: F: Jakarta (Associated Office) Oentoeng Suria & Partners Level 37, Equity Tower Sudirman Central Business District Jl. Jend. Sudirman Kav Jakarta Selatan Indonesia T: F: Broadwalk House 5 Appold Street EC2A 2HA UK T: +44 (0) F: +44 (0) Madrid Alcalá, Madrid Spain T: F: /02 Melbourne Level William Street Melbourne VIC 3000 T: F: Milan Via Sant'Orsola, Milan Italy T: F: Munich Ludwigpalais Ludwigstraße Munich Germany T: +49 (0) F: +49 (0) New York Times Square Tower 7 Times Square New York, NY USA T: F: Paris 18, square Edouard VII Paris France T: +33 (0) F: +33 (0) Perth Level 32, Exchange Plaza 2 The Esplanade Perth WA 6000 T: F: Port Moresby Level 4, Mogoru Moto Building Champion Parade PO Box 850 Port Moresby Papua New Guinea T: F: Rome Via Sistina, Rome Italy T: F: Shanghai Suite CITIC Square 1168 Nanjing Road West Shanghai PRC T: F: Singapore 12 Marina Boulevard #24-01 Marina Bay Financial Centre Tower 3 Singapore T: F: Stockholm Jakobsgatan 6 Box 7124 SE Stockholm Sweden T: +46 (0) F: +46 (0) Sydney Level 36, Grosvenor Place 225 George Street Sydney NSW 2000 T: F: Tokyo Shiroyama Trust Tower 30th Floor Toranomon Minato-ku, Tokyo Japan T: F: Washington DC 1875 K Street NW Washington, DC USA T: F: This publication is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to. Readers should take legal advice before applying the information contained in this publication to specific issues or transactions. For more information please contact us at Broadwalk House, 5 Appold Street, EC2A 2HA T: +44 (0) F: +44 (0) Ashurst LLP and its affiliates operate under the name Ashurst. Ashurst LLP is a limited liability partnership registered in England and Wales under number OC It is a law firm authorised and regulated by the Solicitors Regulation Authority of England and Wales under number The term "partner" is used to refer to a member of Ashurst LLP or to an employee or consultant with equivalent standing and qualifications or to an individual with equivalent status in one of Ashurst LLP's affiliates. Further details about Ashurst can be found at Ashurst LLP 2012 Ref: September 2012

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