RE: Consultation paper on the Draft technical standards on the Regulation (EU) xxxx/2012 on short selling and certain aspects of credit default swaps

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1 Verband der Auslandsbanken Savignystr Frankfurt To the European Securities and Market Authority 103 rue de Grenelle Paris FRANCE Contact: Dr Martin Schulte (TEL) (FAX) martin.schulte@vab.de 13 February 2012\MS via ESMA wbesite RE: Consultation paper on the Draft technical standards on the Regulation (EU) xxxx/2012 on short selling and certain aspects of credit default swaps Dear Madam or Sir, This is a response to the consultation paper referenced above. As a representative of institutions involved in short selling transactions, we appreciate the opportunity to contribute to the issue. For our members (more than 200 foreign banks, asset management, leasing and factoring companies located in Germany), the harmonised European system as opposed to the diverging national rules currently enacted in various Member States is of vital importance. The goal of any future regulation should be to preserve the benefits of short selling (more efficient price discovery, increasing market liquidity, facilitating hedging and other risk management activities and helping to mitigate price bubbles and acting as an early indicator of problems relating to an issuer) while, at the same time, preventing market impairments. We notice that the draft technical standards largely focus on the prevention of settlement failures. In fact, this is a slight turn in the goal of short selling and CDS regulation, which was initially intended to maintain creditworthiness of is- Verband der Auslandsbanken in Deutschland e.v. Association of Foreign Banks in Germany Interessenvertretung ausländischer Banken, Kapitalanlagegesellschaften, Finanzdienstleistungsinstitute und Repräsentanzen Representation of interests of foreign banks, investment management companies, financial services institutions and representative offices Eingetragen im Register der Interessenvertreter der Europäischen Kommission, Registrierungsnummer:

2 suers of bonds and securities. Settlement failures should not be made a major subject of regulatory initiatives since contractual regulations sufficiently sanction such event. Market participants usually do know how to cover a short sale. Besides, even if a settlement failure does occur, no systemic risk is involved. Accordingly, there is currently no situation on EU markets that required some of the measures proposed in the drafts. With regard to Article 6, the requirement to have a directly enforceable claim is sufficient and does not need supplementary confirmations, which would involve unnecessary disclosures and unnecessary extra effort. A third party who offers securities lending or similar services implicitly confirms like any other party offering a particular service that it is capable of it. The confirmation requirement infers that the third party has not sufficiently considered whether it can render its services and thus needs a regulatory reminder. In the absence of empirical data that would support such regulation, this seems quite inappropriate. The confirmation requirements regarding Article 12 of the Regulation should thus not bee designed too narrowly. We hope that our answers to the Consultation paper below are helpful. Yours sincerely Dr. Oliver Wagner Dr. Martin Schulte 2

3 Position Paper Draft EU Regulations on Short Selling and Credit Default Swaps 1. Do you agree with the approach of providing an exhaustive list of types of agreement, arrangement and measure that adequately ensure shares or sovereign debt instruments will be available for settlement and setting out the criteria these should fulfill? To reduce compliance risk for the industry, we do agree in principle on the requirement on having an exhaustive list of the types of agreements, arrangements and measures that adequately ensure that shares or sovereign debt instruments will be available for settlement. However, a periodic review mechanism should be considered to always adequately reflect prevailing market practices. 2. Do you agree with the proposed list of agreements and enforceable claims and the criteria they should meet? Are there any other types of agreement or enforceable claims or criteria which should be added? Since Prime Brokerage Agreements are one of the most common instruments used to cover a short sale, they should be included in the types of agreements or enforceable claims under Section Do you consider that these criteria will entail additional costs as compared to current practices on the market? If so, could you specify the drivers for those additional costs and any indication of their amount? There will not be any significant extra additional costs arising from the implementation of the additional criteria to the current market practices. However, Article 5(3) is a potentially contentious issue that we believe should be omitted from the Implementing Regulation: Article 5 Agreements to borrow and other enforceable claims having similar effect 3

4 3) Where an agreement to borrow or other enforceable claim which has been entered into is revoked or can no longer be fulfilled, the person is no longer deemed to comply with the conditions of Article 12(1)(b) of Regulation (EU) xxxx/2012 for short sale on shares or Article 13(1)(b) of Regulation (EU) xxxx/2012 for short sales on sovereign debt. The failure of counterparty to fulfill a claim on a sale should not lead to breach of the Regulation by the seller. This is because it is practically impossible to sufficiently assess the solvency or liquidity of the counterparty within the short time frame of the business practice. In addition, we believe there are other contractual obligations binding the two parties in the transaction that would render the counterparty liable for breach of contract in case he fails to deliver the shares. There should not be any further regulatory or compliance related obligations meant to achieve the same goal directly or indirectly. 4. Do you agree with the proposed list of third parties which may be parties to the arrangements or measures and the criteria proposed by ESMA that they should fulfill? Basically we do agree with the list of third parties. However, we have not seen any practical evidence or empirical data that justifies the requirements set out in Article 8 (a). An obligation for investment firms to provide such information is absolutely unnecessary considering the costs and effort involved compared to the benefit of minimizing the likelihood of a default of the party providing coverage for a short sale. Moreover, the historical performance of a third party in relation to delivery on an intended settlements date does not necessarily indicate the future credibility of the same party. Moreover, it is impractical and burdensome for the industry as a whole to constantly provide more information about its respective market activities in addition to already existent regulatory obligations which would also achieve the same or similar purpose yet increase its compliance risk. We would thus suggest the following deletion: Article 8 Third parties with whom arrangements are made (a) an investment firm: an investment firm which participates in the management of the borrowing or purchasing of the relevant securities and can provide, on request, statistical evidence for the preceding quarter on the percentage of sales of shares or sovereign debt, including data on short 4

5 sales, that it processed or covered that were delivered on the intended settlement date; We also suggest that clear guidance must be provided to member countries to specify which countries meet the equivalent definition set out under part (g). Besides, the requirement to provide statistical evidence is, for the reasons stated under Q4, not necessary to minimize the risk of settlement failures: Article 8 Third parties with whom arrangements are made (g) any other person subject to authorization or registration requirements in accordance with Union Law by a member of the European system of the European Financial Supervision or equivalent third country authority which participates in the management of the borrowing or purchasing of the relevant securities and can provide, on request, statistical evidence for the preceding quarter on the percentage of sales of shares or sovereign debt, including data on short sales, that it processed or covered that were delivered on the intended settlement date. 5. Are there further criteria which should be added? Yes. Agent lenders and underlying principals should be included. 6. Does the fact that a third party should be a distinct legal entity from the entity entering into the short sale entail costs? If so please provide estimates of those costs. The fact that a third party should be a distinct legal entity does indeed increase costs. As a result of well-established market practices, the third party could result from internal trading desks within the same source. This naturally reduces the costs the banks undertake for these services as another party would ultimately charge higher fees for the same service. It is therefore not beneficial for the industry to set a distinct legal entity requirement for third party transactions and contradicts common market practice that did not lead to a higher number of settlement failures. 7. Do you agree with the approach proposed by ESMA on the standard/same day/liquid shares locate confirmation arrangements and measures and the criteria that they must fulfill? 5

6 We do not agree with the approach to require a confirmation as proposed by ESMA for intraday short positions since it would significantly affect trading flexibility. Under current German short selling legislation, intraday short positions are rightfully exempted from the short selling ban and there is no confirmation requirement to ensure that the respective shares can be obtained when due. In intraday trading short positions can quickly occur and be closed without causing the effects that short selling legislation intends to avoid. From a practical perspective, it would not be workable to require respective confirmation from a third party. In particular a requirement as stipulated in Article 6, 1) b. ii., requiring the third party to share other information available to that third party showing availability of shares would involve unnecessary sharing of proprietary information: Article 6 Arrangements and measures to be taken in relation to shares ii. Confirmation: a confirmation by the third party, provided prior to the short sale being entered into, that the share is easy to borrow or purchase in the relevant quantity taking into account the market conditions and other information available to that third party on the supply of the shares; 8. In circumstances other than intraday short selling or short selling on liquid shares, can you suggest any additions to the methods for effective allocation set out in this consultation paper which would provide the necessary comfort that shares can be delivered for settlement in due time? Please refer to our comments for question 7 above. 9. In relation to the approach suggested for liquid shares, do you consider it appropriate to use the MiFID definition of liquid shares? Do you think ESMA should consider different approaches to determine the reasonable expectation test for liquid and illiquid shares? If not, can you provide indications as to the criteria to consider to define liquid shares or to take into account the liquidity of the shares in these circumstances? Is securities lending activity an additional factor to consider when determining liquidity of a share? 6

7 We consider that the proposed use of the MiFID definition of liquid shares is only appropriate when looking at liquidity for the settlement of sales of securities if the intraday criteria was removed. 7