Finance ministers strike deal on short selling

EU member states’ finance ministers have reached a deal intended to limit and improve the transparency of two trading practices that have been most criticised in the wake of the financial crisis of 2007-08.

Ministers agreed a common approach to rules covering short selling – a practice in which traders sell a security at a high price in the expectation that they will be able to buy it again at a lower price – and on the trade in credit default swaps, a form of insurance that guarantees the creditworthiness of a loan.

Under the compromise reached today, short selling will be banned when a trader borrows the security– a practice known as ‘naked short selling’. This will not apply to the short selling of government debt if the deal is made to hedge against a long position in that instrument.

The ban on naked short selling of sovereign debt can also be suspended if the liquidity of sovereign debt falls below a certain threshold.

Short trades will have to be notified either to the market regulator or, in cases of a more significant trade, to the markets themselves.

The legislation was proposed by the European Commission in 2010 to establish common rules on short selling and credit default swaps. Several member states, including the UK and Germany, had introduced bans on short selling in 2008 at the height of the financial crisis to prevent instability in financial markets.

The common position agreed by finance ministers today will form the basis for negotiations with the European Parliament on the final shape of legislation. The Parliament’s position was more restrictive than that approved by finance ministers and included a ban on naked sales of credit default swaps.

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