Commonwealth of Australia Explanatory Memoranda Commonwealth of Australia Explanatory Memoranda[Index] [Search] [Download] [Bill] [Help]
2008
THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA
HOUSE OF REPRESENTATIVES
Corporations amendment (short selling) bill 2008
EXPLANATORY MEMORANDUM
(Circulated by the authority of the
Minister for Superannuation and Corporate Law, Senator the Hon Nick Sherry)
Table of contents
Glossary 1
General outline and financial impact 3
Outline 3
Summary of regulation impact statement 4
Regulation impact on business 4
Chapter 1 Introduction 5
Chapter 2 Schedule 1 - Amendments commencing on Royal Assent 7
Chapter 3 Schedule 2 - Amendments commencing on the 28th day after
Royal Assent 11
Chapter 4 Schedule 3 - Amendments commencing on Proclamation 15
Chapter 5 Regulation impact statement 25
Index 35
Do not remove section break.
The following abbreviations and acronyms are used throughout this
explanatory memorandum.
|Abbreviation |Definition |
|Corporations Act |Corporations Act 2001 |
|AFS Licensee |Australian Financial Services|
| |Licensee |
|ASIC |Australian Securities and |
| |Investments Commission |
|ASX |Australian Securities |
| |Exchange |
|Bill |Corporations Amendment (Short|
| |Selling) Bill 2008 |
General outline and financial impact
Outline
The Corporations Amendment (Short Selling) Bill 2008 (the Bill)
addresses certain aspects of the regulation of short selling. The
Bill contains three key measures:
. Clarification of ASIC's powers: The Bill clarifies ASIC's
powers to regulate short selling of financial products and
transactions that have a substantially similar market
effect as short sales under the Corporations Act. These
amendments are for the avoidance of doubt and aim to
provide certainty to both ASIC and industry regarding the
scope of ASIC's powers in this area.
. Prohibition on naked short selling: The Bill repeals
sections of the Corporations Act that allow certain
financial products to be sold even though the seller does
not have a presently exercisable and unconditional right
to vest the products in the buyer. In a general sense,
these transactions are commonly known as 'naked short
sales'.
. Disclosure of covered short sales: The Bill requires the
disclosure of covered short sale transactions. Covered
short sales are sales supported by securities obtained
under a securities lending agreement. Regulations will
set out the timing and manner of the disclosures.
Date of effect: Sections 1 to 3 of the Bill commence on Royal
Assent. Schedule 1 of the Bill commences on Royal Assent.
Schedule 2 commences on the 28th day after Royal Assent. Schedule
3 commences on a single day fixed by Proclamation but no later than
12 months after the Act receives Royal Assent.
Financial impact: This Bill has no significant impact on
Commonwealth expenditure or revenue.
Compliance cost impact: In relation to the clarification of ASIC's
powers (Schedule 1), these measures are not considered to have a
regulatory impact because they are designed to provide certainty in
relation to the scope of ASIC's powers.
In relation to the prohibition on naked short sales (Schedule 2),
these measures have a low compliance cost impact on business
because of the limited occurrence of naked short selling on
Australian financial markets.
In relation to the disclosure regime (Schedule 3), these measures
have a transitional and ongoing compliance cost impact on business.
The amount of the compliance cost impact will be determined by the
details to be prescribed through Regulations. As such, it is not
possible to quantify the costs until the Regulations are made.
These issues are outlined in the Regulation Impact Statement.[1]
Summary of regulation impact statement
Regulation impact on business
Impact: The amendments have a transitional and ongoing regulatory
impact on investors that engage in covered short sale transactions,
AFS Licensees (brokers) that execute covered short sale
transactions and financial market operators.
Main points:
. The disclosure regime will mean greater transparency in
relation to covered short sales in Australian financial
markets. This will assist in enhancing market confidence
by reducing market rumour and speculation about the
activity of short sellers.
. The main cost of the regime is the compliance burden for
investors, brokers and market operators that are required
to collect and report information relating to covered
short sales.
Chapter 1
Introduction
Clause 1: Short title
1. The Act may be cited as the Corporations Amendment (Short Selling)
Act 2008.
Clause 2: Commencement
2. Sections 1 to 3 are formal provisions and commence on Royal Assent.
Schedule 1 is to commence on Royal Assent. Schedule 2 is to
commence on the 28th day after Royal Assent. Schedule 3 is to
commence on a date to be fixed by proclamation. However if the
provisions do not commence within 12 months of the Act receiving
Royal Assent, they commence on the first day after the end of that
period.
3. Schedule 3 contains the amendments to require the disclosure of
covered short sale transactions. This provision will commence on
proclamation to provide sellers and AFS Licensees with a
transitional period before compliance with the law is required. It
is understood that the new disclosure regime will require IT and
other administrative changes. While the scope of the IT and other
administrative changes will not be fully known until regulations
are in place, some parts of industry have suggested the changes may
take up to 12 months to complete in order to enable electronic
reporting of these transactions.
Clause 3: Schedules
4. Schedule 1 amends existing section 1020F of the Corporations Act
and inserts new section 1484 to clarify ASIC's existing powers in
relation to short selling. Schedule 2 amends existing section
1020B to prohibit certain short sales. Schedule 3 inserts new
Division 5B in Part 7.9 to require the disclosure of covered short
sale transactions.
Do not remove section break.
Outline of chapter
5. Schedule 1 of the Bill contains amendments to clarify ASIC's powers
under the Corporations Act 2001 in relation to short selling.
Context of amendments
6. ASIC has the power under paragraph 1020F(1)(c) of the Corporations
Act to omit, modify or vary certain parts of the Corporations Act
through declarations. These declarations generally take the form
of Class Orders issued by ASIC.
7. In September 2008, ASIC used this power to issue a declaration that
required the disclosure of covered short sales. However, shortly
after this declaration, ASIC took further action to ban covered
short sales. The disclosure requirements applied to covered short
sale transactions taking place because of the exceptions to the
ban. This declaration was made in light of the unprecedented
volatility experienced on Australian and global financial markets
during this period and international regulatory developments
occurring at the time. ASIC has since made a number of other
declarations providing limited relief from the short selling ban.
8. ASIC's power to omit, modify or vary the Corporations Act through
declarations is general in nature. Given that ASIC may be using
these powers to respond to emergency situations, it is essential to
address any possible uncertainty surrounding the scope of ASIC's
powers. The amendments are designed to put the matter of ASIC's
powers in relation to short selling beyond doubt.
Summary of new law
9. The Schedule contains two key reforms:
. The first reform amends ASIC's general exemption and
modification power in section 1020F of the Corporations
Act to clarify that it includes specific actions in
relation to any form of short selling and transactions
with a substantially similar market effect as short
selling.
. The second reform amends the Corporations Act to expressly
state that the declarations made by ASIC in relation to
short selling were within the scope of its power to omit,
modify or vary certain parts of the Act.
10. Both reforms are for the avoidance of doubt only.
Comparison of key features of new law and current law
|New law |Current law |
|ASIC's powers to omit, |ASIC's powers to omit, |
|modify or vary certain |modify or vary certain |
|parts of the Corporations|parts of the Corporations|
|Act clarified in relation|Act are general in |
|to any form of short |nature. |
|selling and transactions | |
|with a substantially | |
|similar market effect as | |
|a short sale of financial| |
|products. | |
|ASIC's declarations on |ASIC's declarations on |
|short selling expressly |short selling not |
|stated to be within |expressly stated as being|
|ASIC's powers under the |within ASIC's power under|
|Corporations Act. |the Corporations Act. |
Detailed explanation of new law
11. Item 1 of Schedule 1 to the Bill amends existing section 1020F of
the Corporations Act to clarify the application of ASIC's powers
under paragraph 1020F(1)(c) in relation to any form of short
selling of financial products and transactions with the same or
substantially similar market effect as a short sale of financial
products. Transactions with a substantially similar market effect
are not limited to transactions that occur on a market licensed
under the Corporations Act. It may include transactions that occur
off a licensed market if it can be proven that the transaction has
the same or substantially similar market effect as a short sale
transaction. [Schedule 1, item 1]
12. Item 1 clarifies the application of ASIC's powers under paragraph
1020F(1)(c) in relation these transactions. In particular, it
amends section 1020F to state that ASIC has the power to make
declarations:
. suspending, prohibiting or limiting these transactions;
. varying requirements under Part 7.9 that apply to these
transactions;
. removing some or all requirements under Part 7.9 that
apply to these transactions; and
. imposing requirements that apply to these transactions.
[Schedule 1, item 1]
13. The amendments are made for the avoidance of doubt and are intended
to remove any uncertainty in relation to the application of ASIC's
powers to short selling transactions and transactions with the same
or substantially similar market effects as short sale transactions.
14. Item 2 of Schedule 1 to the Bill is designed to put beyond any
doubt that the Class Orders specified in new subsection 1484(2)
were validly made. These Class Orders were made by ASIC under
paragraph 1020F(1)(c) of the Corporations Act. In substance, the
Class Orders imposed a ban on covered short selling subject to
limited exemptions and required disclosure in relation to the
exempted transactions. The Class Orders were made publicly
available by being published on the Federal Register of Legislative
Instruments and on ASIC's website. Steps were also taken to
through the Australian Securities Exchange to inform market
participants. [Schedule 1, item 2]
15. The amendment is necessary, in order to put beyond any doubt that
individuals who organised their affairs in accordance with the
Class Orders have complied with the requirements of the
Corporations Act and may, with confidence, continue to conduct
their affairs accordingly. The Class Orders were publicly
available and expressed to have valid and binding legal effect.
The amendment operates for the benefit of parties who organised
their affairs in accordance with the Class Orders, and will,
importantly, provide certainty to business.
16. Further, new subsection 1484(3) puts beyond any doubt that Class
Orders that are of substantially the same nature as the instruments
mentioned in subsection 1484(2), and that are made after 24 October
2008 and before commencement of section 1484, are validly made.
These Class Orders (if any) should be publicised in essentially the
same way as the Orders specified in subsection 1484(2). The
amendment also clearly alerts market participants to the future
status of such Orders under the Corporations Act.
Application and transitional provisions
17. Item 1 of Schedule 1 applies from the date of commencement (that
is, on Royal Assent). Item 2 of Schedule 1 applies on and from
19 September 2008. This is date on which ASIC issued its first
declaration relating to short selling (it was subsequently lodged
on the Federal Register of Legislative Instruments on 22 September
2008). [Schedule 1, item 2]
Do not remove section break.
Outline of chapter
18. Schedule 2 of the Bill contains amendments to prohibit certain
short sale transactions.
Context of amendments
19. The Corporations Act, at subsection 1020B(2), provides that a
person can only sell certain financial products if the person has,
or believes on reasonable grounds that they have, a presently
exercisable and unconditional right to vest the products in the
buyer. If the person is selling the products on behalf of another
person (for example, a broker selling on behalf of a client), the
other person (the client) must have, or believe on reasonable
grounds that they have, a presently exercisable and unconditional
right to vest the products in the buyer.
20. The Act, however, allows certain exceptions to this rule. For the
most part, the exceptions to this rule are commonly referred to as
'naked short sales'.
21. Various concerns have been expressed in relation to naked short
selling. Transactions of this nature may have a higher risk of
settlement failure (because the seller does not have a presently
exercisable and unconditional right to vest the products at the
time of sale). They may also distort the operation of financial
markets by causing increased price volatility and potentially
facilitating market manipulation. In addition, the perceived
activity of naked short sellers is likely to damage market
confidence particularly among retail investors. For these reasons,
naked short selling has the potential to damage the integrity of
Australian financial markets.
22. In light of this, and given the limited evidence of any
significant, market-wide benefits from naked short sale
transactions, it was considered appropriate to remove the general
ability for people to enter into these transactions under the
Corporations Act.
Summary of new law
23. The amendments prohibit naked short selling.
24. Under section 1020F of the Corporations Act, ASIC has the ability
to grant exemptions from this prohibition.
Comparison of key features of new law and current law
|New law |Current law |
|The seller of section |Includes some exceptions |
|1020B products must have |from the requirement for |
|a presently exercisable |a seller to have a |
|and unconditional right |presently exercisable and|
|to vest the products in |unconditional right to |
|the buyer. There are no |vest the products in the |
|exceptions from this |buyer. In general, these|
|requirement that would |exceptions allow for |
|allow for naked short |naked short selling of |
|selling. However, ASIC |section 1020B products. |
|has the power to issue | |
|exemptions from the | |
|prohibition. | |
Detailed explanation of new law
25. The amendment removes the exceptions from the existing requirement
in subsection 1020B(2) for a person selling a section 1020B product
to have, or believe on reasonable grounds they have, a presently
exercisable and unconditional right to vest the products in the
buyer. If the person is selling the products on behalf of another
person (for example, a broker selling on behalf of a client), the
other person (the client) must have, or believe on reasonable
grounds they have, a presently exercisable and unconditional right
to vest the products in the buyer.
26. In particular, Schedule 2 repeals exceptions from
subsection 1020B(2) relating to:
. odd lot transactions (existing paragraph 1020B(4)(a));
. arbitrage transactions (existing paragraph 1020B(4)(b));
. transactions where arrangements have been made before the
time of sale that will enable delivery of the products in
time for settlement (existing paragraph 1020B(4)(d)); and
. transactions made under a declaration from the operator of
a licensed market in accordance with the operating rules
of the market (existing paragraph 1020B(4)(e)).
[Schedule 2, item 2]
27. In addition, existing subsections 1020B(5) and 1020B(6) and section
1020C relating to the operation of subsections 1020B(4)(b),
1020B(4)(d) and 1020B(4)(e) are repealed because they are no longer
necessary. [Schedule 2, items 2 and 3]
28. Schedule 2 inserts new subsection 1020B(4) made up of the existing
paragraph 1020B(4)(c). This subsection applies to circumstances
where a seller has previously purchased the section 1020B products
being sold, but that purchase agreement is conditional only upon a
limited range of factors. This subsection allows a seller to sell
the products acquired through the purchase agreement even though
the seller may not have a presently exercisable and unconditional
right to vest the products in the buyer because the purchase
agreement to acquire the products is still conditional at the time
of sale. The existence of the prior purchase agreement means that
the transaction falls short of true naked short selling. For this
reason, it is not necessary to repeal this exception. [Schedule 2,
item 2]
29. ASIC has the power under section 1020F to issue exemptions for
subsection 1020B(2) that would allow naked short sales in certain
circumstances.
Consequential amendments
30. Schedule 2 amends subsections 1020B(1), 1200F(1) and Schedule 3 of
the Corporations Act to remove references to sections that are
repealed by the Bill. [Schedule 2, items 1, 4 and 5]
Do not remove section break.
Outline of chapter
31. Schedule 3 amends the Corporations Act 2001 (the Corporations Act)
to require the disclosure of transactions to sell section 1020B
products when the seller has entered into a securities lending
arrangement.
Context of amendments
32. The Corporations Act, at section 1020B, currently regulates short
selling of securities, managed investment products and certain
other financial products (section 1020B products).
33. Section 1020B generally prohibits the sale of a section 1020B
product unless a person has a 'presently exercisable and
unconditional right' to vest the product at the time of sale.
34. Short sellers need to make arrangements to cover their delivery
obligations before they fall due. This is normally done by:
. making a matching purchase at some point following the
sale but before delivery falls due; or
. borrowing an equivalent amount of securities before
delivery falls due, either before they enter into the sale
or at some time between making the sale and when required
to make delivery.
35. A naked short sale occurs where a seller does not own or has not
borrowed or arranged to borrow securities at the time of sale but
intends to purchase or borrow securities in order to meet the three
business day settlement obligation.
36. There is some discussion about what constitutes a covered short
sale. The broadest approach is to focus on whether borrowing takes
place to meet delivery obligations. On this approach a covered
short sale occurs where the seller has arranged to borrow stock in
order to meet their delivery obligations.
37. A borrowing arrangement (or securities lending arrangement) occurs
where the seller enters into an agreement or arrangement with a
lender under which the section 1020B products will be delivered to
the seller, and title transferred, on the condition that the seller
will return, at a future date, the original or equivalent
replacement section 1020B products to the lender. Loans in
Australia are often made using a standard form of contract, the
Australian Master Securities Lending Agreement.
38. While a borrowing agreement is economically a loan, there is a
legal transfer of title between the lender and borrower, which
allows the borrower to vest title to the section 1020B products in
another person.
39. There is uncertainty around the use of stock lending agreements,
the application of subsection 1020B(2), and therefore the
requirement to disclose to a financial services licensee, in
certain circumstances, that the transaction is a short sale
(subsection 1020B(5)). It is understood that most market
participants consider that a covered short sale falls within
subsection 1020B(2) and so need not be disclosed.
40. Market practice has developed so that covered short sales are not
usually reported to the market on the argument that they are not
truly 'short' because the seller, relying on the borrowed stock,
has a 'presently exercisable and unconditional right to vest the
product' at the time of sale. Some limited reporting does occur.
41. While a person may borrow stock any time after the sale in order to
meet delivery, subsection 1020B(2) requires that a person has a
'presently exercisable and unconditional right to vest the product'
at the time of sale. If this is not the case, section 1020B
applies to the sale.
42. ASIC Regulatory Guide 196 sets out the circumstances in which a
seller has a 'presently exercisable and unconditional right to vest
the product' in relation to a borrowing agreement.
43. The amendments will ensure that covered short sales are disclosed.
Summary of new law
44. The amendments require sellers of section 1020B products to advise
their executing AFS Licensee when the sale is a covered short sale
(a short sale supported by a securities lending arrangement). In
turn, the AFS Licensee must report the disclosed covered short
sales to the relevant market operator. AFS Licensees must also
report principal covered short sales to the relevant market
operator.
45. The market operator must publicly disclose reported short sale
information.
46. The disclosure regime applies to sales made on a licensed market
(such as the ASX) and sales that occur through on or off market
crossings.
47. The disclosure requirement applies whether the seller is inside or
outside Australia.
48. It is an offence if sellers and AFS Licensees do not provide
particulars of the sale of section 1020B products, at the time and
in the manner required by the regulations. Regulations will set
the mechanics of disclosure from sellers to AFS Licensees and AFS
Licensees to the market operator, including when and how disclosure
occurs. Regulations will also set the manner and time of public
disclosure by the market operator, which will include the
disclosure of aggregate short sale information.
49. To complement the disclosure regime, AFS Licensees must also ask
whether the sale is a covered short sale before making the sale.
This should assist in ensuring that clients, particularly overseas
clients, understand their obligations to report those short sales.
It is an offence if AFS Licensees do not make these inquiries.
Comparison of key features of new law and current law
|New law |Current law |
|Disclosure of short sales covered by securities |
|lending agreements |
|Sellers of section |Covered short sales are not |
|1020B products must |usually reported to the |
|advise their |market on the argument they |
|executing Australian|are not truly 'short' because|
|Financial Services |the seller, relying on the |
|(AFS) Licensee when |borrowed stock, has a |
|the sale is a |'presently exercisable and |
|covered short sale. |unconditional right to vest |
|The AFS Licensee |the product' at the time of |
|must report the |sale. Some limited reporting|
|disclosed client |does occur. |
|short sales to the | |
|relevant market | |
|operator, while also| |
|reporting the AFS | |
|Licensee own | |
|principal covered | |
|short sales. | |
|The time and manner | |
|of disclosure will | |
|be contained in the | |
|regulations. | |
|AFS Licensee inquiry obligation |
|The AFS Licensee |There is no current AFS |
|must not make a sale|Licensee inquiry obligation |
|of a section 1020B |in the Corporations Act. On |
|product unless the |19 September 2008, ASIC used |
|AFS Licensee has |its modification power under |
|asked the seller |section 1020F of the |
|whether they are |Corporations Act to impose a |
|required to disclose|similar AFS Licensee inquiry |
|that the sale is a |obligation. This inquiry |
|covered short sale. |obligation is designed to |
|AFS Licensees must |operate until these |
|also record the |amendments commence. |
|seller's answer. |The ASX market rules include |
| |a similar inquiry obligation |
| |on ASX participants but this |
| |does not, in practice, apply |
| |to covered short selling as |
| |the market generally |
| |perceives that the ASX rules |
| |do not apply to covered short|
| |selling. |
Comparison of key features of new law and current law (continued)
|New law |Current law |
|Public disclosure by market operator of short sale|
|information |
|The market operator |The ASX currently discloses |
|(for example the |aggregate short sale |
|ASX) must publicly |information it receives under|
|disclose the short |section 1020B but there is no|
|sale information it |express legal requirement for|
|receives in the |it to do so. |
|manner and time | |
|contained in the | |
|regulations. | |
Detailed explanation of new law
50. Schedule 3 inserts Division 5B of Part 7.9 of the Corporations Act
to require disclosure of short sales of section 1020B products
covered by a securities lending arrangement. [Schedule 3, item 3]
Key definitions for Division 5B
51. crossing: an AFS Licensee makes a sale of section 1020B products
either on behalf of the buyer and seller of the products, or on
behalf of a client on one side of the trade and as principal on the
other side. [Schedule 3, item 3, subsection 1020AA(1)]
52. sale: the entering into an agreement to sell section 1020B
products is treated as the sale of the products. [Schedule 3, item
3, subsection 1020AA(2)]
53. section 1020B products: securities, managed investment products, a
debenture, stock or bond issued or proposed to be issued by a
government or financial products prescribed by regulation (existing
subsection 1020B(1)). Regulation 7.9.80B prescribes certain
financial products for the purposes of subsection 1020B(1).
[Schedule 3, item 3, subsection 1020AA(1)].
54. securities lending arrangement: the lender agrees to deliver
particular financial products to the borrower, and vest title, on
the condition that the borrower will return, at a future date, the
original or equivalent replacement financial products to the
lender, and vest title. The definition of securities lending
arrangement also encompasses the possibility that the lender will
deliver, and vest title in, the particular financial products to a
third party on the instruction of the borrower, and in return, the
borrower may return the financial products to a third party
nominated by the lender. [Schedule 3, item 3, subsection
1020AA(1)]
Client and principal disclosure
55. The amendment governs client and principal disclosure of short
sales of section 1020B products covered by a securities lending
arrangement. [Schedule 3, item 3, subsection 1020AB(1)]
56. The disclosure requirement applies:
. where an AFS Licensee makes a sale of section 1020B
products on a licensed market, on its own behalf, or on
behalf of a person, to a buyer; [Schedule 3, item 3,
paragraph 1020AB(1)(a)]
. before the time of sale, the seller entered into, or
gained the benefit of, a securities lending arrangement;
[Schedule 3, item 3, paragraph 1020AB(1)(b)]
. at the time of sale, the seller intends that the
securities lending arrangement will ensure that some or
all of the section 1020B products can be vested in the
buyer. [Schedule 3, item 3, paragraph 1020AB(1)(c)]
57. The disclosure requirement applies to both client and principal
trading in section 1020B products on a licensed market. A crossing
of a section 1020B product is treated as being made on a licensed
market. On the ASX, a crossing is conducted by an ASX participant
but may occur on or off-market. Crossings are treated as being
made on a licensed market, whether the crossing occurs on or off-
market. [Schedule 3, item 3, subsection 1020AA(4)]
58. The definition of securities lending agreement covers the
circumstances where a seller has entered a securities lending
arrangement, or received the benefit of such an arrangement, before
the time of sale. Such a benefit could arise if the borrower
directed the lender to vest the section 1020B products in a third
party, who subsequently short sells. [Schedule 3, item 3,
subsection 1020AA(1) and paragraph 1020AB(1)(b)]
59. For the avoidance of doubt, the amendments clarify that a sale in
economic substance is treated as if the sale is made by an AFS
Licensee on behalf of a person. An example includes that a sale
request is passed from the person to the AFS Licensee through a
chain of intermediaries. [Schedule 3, item 3, subsection
1020AA(3)]
Mechanics of disclosure
60. It is an offence if client and principal sellers (AFS Licensees) do
not provide particulars of the sale of 1020B products, at the time
and in the manner required by the regulations. The particulars
include when disclosure occurs and the manner of such disclosure.
[Schedule 3, item 3, subsection 1020AB(3)]
61. This will facilitate disclosure from client sellers to AFS
Licensees, and AFS Licensees (as principal sellers) to the market
operator. [Schedule 3, item 3, subsection 1020AB(4)]
62. Details about the mechanics of disclosure are to be included in the
regulations so that the regime is able to adapt more readily to the
rapid and ever evolving changes in markets, and the mechanisms by
which transactions occur. The matters to be contained in the
regulations will specify the technical requirements of disclosure.
63. The penalty for the offence is the same as the penalty that was in
place under the former short selling disclosure regime under
repealed subsection 1020B(5). [Schedule 2, item 2] The penalty is
25 penalty units or imprisonment for six months, or both.
[Schedule 3, item 6]
64. The requirement to provide particulars of the sale of section 1020B
products, at the time and in the manner required by the
regulations, applies whether the seller is inside or outside
Australia. [Schedule 3, item 3, subsection 1020AB(2)]
65. The ability of the regulations to allow things to be specified
differently for different kinds of persons, things or circumstances
may be relevant in this context. For example it may not be
possible for all kinds of sellers to comply with the same mechanics
of disclosure under the regulations. [Schedule 3, item 3, section
1020AF]
AFS Licensee disclosure
66. AFS Licensee must disclose short sales covered by a securities
lending arrangement where an AFS Licensee receives information from
a client on the particulars of the sale of section 1020B products
on a licensed market. [Schedule 3, item 3, paragraph 1020AC(1)(a)]
Mechanics of disclosure
67. It is an offence if AFS Licensees do not provide particulars of
disclosed client sales of section 1020B products, at the time and
in the manner required by the regulations. The particulars include
when the disclosure occurs and the manner of such disclosure.
[Schedule 3, item 3, subsection 1020AC(2)]
68. This will facilitate disclosure from AFS Licensees to the relevant
market operator. [Schedule 3, item 3, subsection 1020AC(3)]
69. The penalty for the offence is the same as the penalty for non
disclosure by the seller under section 1020AB. The penalty is 25
penalty units or imprisonment for six months, or both [Schedule 3,
item 6].
Public disclosure of information
70. The relevant market operator must make a public disclosure of the
sale of section 1020B products on a licensed market where they
receive information from:
. the AFS Licensee who provides proprietary short sale
information to the market operator in accordance with
section 1020AB. [Schedule 3, item 3,
subparagraph 1020AD(1)(a)(i)]
. the AFS Licensee who provides client short sale
information to the market operator in accordance with
section 1020AC. [Schedule 3, item 3, subparagraph
1020AD(1)(a)(ii)]
. Directly from the seller (client) mentioned in
subparagraph 1020AB(1)(a)(i). This relates to where
regulations specify that the client seller discloses to
another entity other than the AFS Licensee under
subparagraph 1020AB(4)(a)(ii) (see further regulation
making power) [Schedule 3, item 3, subparagraph
1020AD(1)(a)(iii)]
Mechanics of disclosure
71. It is an offence if the relevant market operator does not provide
particulars of disclosed client and proprietary sales of section
1020B products, at the time and in the manner required by the
regulations. The particulars include when the disclosure occurs
and the manner of such disclosure. [Schedule 3, item 3, subsection
1020AD(2)]
72. This will facilitate the public disclosure of aggregate and
reportable short sale information.
73. The penalty for the offence is the same as the penalty for non
disclosure by the seller under section 1020AB. The penalty is 25
penalty units or imprisonment for six months, or both. [Schedule
3, item 6]
Licensee's obligation to ask seller about short sale
74. Where an AFS Licensee is to make a sale of section 1020B product,
on behalf of a person (client), and the AFS Licensee is responsible
under section 1020AB for receiving short sale information from
client sellers, the AFS Licensee must, before the sale:
. ask the seller, orally or in writing, whether the seller
is required under section 1020AB to give them information
in relation to the sale; and
. record the seller's answer in writing [Schedule 3, item 3,
section 1020AE].
75. Under section 25 of the Acts Interpretation Act 1901, writing
includes any mode of representing or reproducing words, figures,
drawings or symbols in a visible form.
76. It is an offence if the licensee does not comply with
section 1020AE. The penalty for the offence is the same as the
penalty for non disclosure by the seller under section 1020AB. The
penalty is 25 penalty units or imprisonment for six months, or
both. [Schedule 3, item 6]
Other regulation making powers
77. New Division 5B of Part 7.9 permits other regulations to be made,
which could amend the operation of the disclosure requirement to:
. require the client (seller) to disclose to an entity other
than the AFS Licensee; [Schedule 3, item 3,
subparagraph 1020AB(4)(a)(ii)]
. require the AFS Licensee to disclose short sale
information (from proprietary or client trading) to an
entity other than the market operator. [Schedule 3, item
3, subparagraph 1020AB(4)(b)(ii) and paragraph
1020AC(3)(b)] That entity will also be responsible for
public disclosure; [Schedule 3, item 3, section 1020AD]
. specify the kind of section 1020B products the disclosure
regime applies to; [Schedule 3, item 3,
subparagraphs 1020AB(1)(d)(i)(ii), 1020AC(1)(b)(i)(ii))
and 1020AD(1)(b)(i)(ii)]
. specify circumstances in which the sale is made; and
[Schedule 3, item 3, subparagraphs 1020AB(1)(d)(iii),
1020AC(1)(b)(iii)) and 1020AD(1)(b)(iii)]
. allow matters or things to be specified differently for
different kinds of persons, things or circumstances.
[Schedule 3, item 3, section 1020AF]
78. This does allow, in future, an alternative approach to disclosure,
which could change the vehicle for disclosure (for example,
requiring sellers to disclose direct to a regulator) and target
disclosure of covered short sales to particular circumstances.
This flexibility is included:
. to allow the law to respond to an environment of rapid
change, including technological innovation and ongoing
developments in the conduct and structures of financial
markets; and
. because the new disclosure requirement will facilitate
greater understanding of this area and may reveal a case
for change to target the disclosure requirement to better
serve the objectives of disclosure. One example could
include targeting of reporting requirements to particular
kinds of section 1020B products, such as securities of a
particular sector.
Consequential amendments
79. The amendment reflects that new Division 5B applies in relation to
securities and debentures, stocks and bonds issued by government.
[Schedule 3, items 1 and 2]
80. The amendment reflects that the definition of section 1020B
products is applicable also to Division 5B. [Schedule 3, item 4]
81. The amendment reflects that the new short selling disclosure
provisions are not excluded from recognised offers under Chapter 8
of the Corporations Act. Section 1200F(1) of the Act lists
provisions that do not apply to recognised offers with New Zealand.
Short selling provisions, however, do apply. [Schedule 3, item 5,
subsection 1200F(1)]
Do not remove section break.
Policy objective
82. There has been significant speculation in recent months regarding
the activity of short sellers in Australian listed securities.
Short selling is an activity where a person enters into an
agreement to sell a security that the person does not currently
own. Short sellers need to make arrangements to cover their
delivery obligations to the buyer before they fall due (usually
three trading days after the transaction is executed). This is
normally done by:
. making a matching purchase at some point following the
sale but before delivery falls due; or
. borrowing an equivalent amount of securities before
delivery falls due, either before they enter into the sale
or at some time between making the sale and when required
to make delivery.
83. There are two types of short sale transactions: naked and covered.
A naked short sale occurs when a seller does not own and has not
borrowed or arranged to borrow securities at the time of sale but
intends to purchase or borrow securities in order to meet the
delivery obligation. A covered short sale occurs when the seller
has entered into an agreement to borrow the security in order to
meet their delivery obligations prior to entering into the
arrangement to sell the security.
84. Currently, short selling of Australian securities is prohibited
under the Corporations Act 2001 unless a person has a 'presently
exercisable and unconditional right' to vest the product at the
time of sale. The prohibition is subject to a number of
exemptions, which permit short selling in a defined range of
circumstances. The most commonly used exemption allows a person to
enter into naked short sale transactions subject to some conditions
imposed by the Australian Securities Exchange (ASX) through its
Market Rules. These conditions place a limitation on the range of
securities that can be subject to naked short sales and requires
disclosures surrounding these transactions. Reported end of day
net-short positions reported to ASX are between 0 and 2 per cent of
share trading volume.
85. In relation to covered short sale transactions, market practice has
developed so that these transactions avoid the prohibition in the
Corporations Act on the grounds that the seller is not truly
'short'. This is based on the argument that the seller, relying on
the agreement to borrow stock, has a 'presently exercisable and
unconditional right to vest the product' at the time of sale. As a
result of this, there is currently very little regulation relating
to covered short sale transactions involving Australian securities.
As a result of this, there is currently no disclosure applicable
to these transactions. This makes it difficult to determine the
amount of covered short sale activity taking place in Australian
securities. However, it is believed that covered short sales are
more common than naked short sales. An estimate of the amount of
covered short selling activity can be derived from measures of the
total value of securities available for lending. The Reserve Bank
of Australia has reported that the value of equities loans
outstanding was around $60 billion at the end of 2007.
86. It should be noted that some borrowed securities are used for
purposes other than short selling (for example, parties may enter
into a securities lending agreement to facilitate an arbitrage
transaction relating to the security or to cover potential
settlement failures), so this figure overstates the amount of
covered short sale activity. It is impossible to determine exactly
the proportion of stock lending transactions that are used for
covered short sales. For this reason, stakeholders, including the
ASX, have questioned whether stock lending data can be used as a
reliable proxy for the amount of covered short sales.
87. Based on the data above, it is estimated that the upper limit of
short selling activity in Australian securities is approximately
$60 billion. This equates to approximately 4 per cent of the total
capitalisation of Australian listed securities (based on a total
ASX market capitalisation of $1.5 trillion). The majority of this
is expected to be in the form of covered short sales. The current
uncertainty surrounding the actual level of short selling activity
in Australian securities is compounding the direct impact of this
activity as it is resulting in rumour and speculation in the
marketplace.
Issue
88. The current degree of uncertainty surrounding the activity of
covered short sellers in Australian securities is having a
significant impact on Australian capital markets. Currently, when
a security experiences a significant decline in price, it is
unclear whether this is attributed to short selling activity or
other factors, which is resulting in considerable rumour and
speculation regarding short selling activity and potentially adding
to price volatility. Speculation regarding the level of short
selling activity in Australian securities is also having broader
market implications. Confidence in the market, particularly among
retail investors, is likely to be damaged as investors express
concern about the perceived activity of short sellers in the
market. A fall in market activity, and investor confidence about
the integrity of Australian capital markets, will make it more
difficult for companies to raise additional capital leading to an
increase in the companies overall cost of capital and a fall in
investment activity.
Objectives
89. The objective of Government action in this area is to increase
transparency surrounding the activity of covered short sellers in
Australian securities. This would provide useful information to
investors and regulators and also contribute to confidence and
market integrity. In particular, disclosure of covered short
selling activity:
. will provide an early signal that individual securities
may be overvalued;
. will indicate that a proportion of the sales in an
individual security will need to be reversed by new
purchases (to cover the short seller's settlement
obligations);
. will enhance investors' willingness to participate in the
market by removing uncertainty surrounding the level of
short selling; and
. may deter market abuse or reduce the opportunities for
market abuse.
90. The Government is not seeking to prohibit or discourage covered
short selling activity. It is recognised that covered short
selling activity, appropriately regulated, is beneficial to the
operation of capital markets by increasing market liquidity and
pricing efficiency.
Implementation options
Option one: Retain the status quo (no regulatory action)
91. This involves retaining the current regulatory arrangements and
seeking to encourage voluntary disclosure of covered short sales.
Option two: Disclosure of covered short sales to brokers
92. This involves placing an obligation on investors to disclose
covered short sale transactions to their broker. The broker will
then be responsible for reporting this information to the relevant
entity, for example, the market operator.
93. Under this option, the general disclosure requirement and the
penalties for failing to disclose information would be contained in
the Corporations Act. However, supplementary regulations would be
used to outline the technical aspects of the requirement including
the timing of any disclosure and whether the investor is required
to disclose transactions on a gross or net basis (gross disclosure
would encompass any covered short sale transaction entered into by
the investor whereas net disclosure would take into account any
offsetting transactions entered into by the investor so only their
net exposure was disclosed). Specifying the technical aspects of
the disclosure requirement in regulations provides sufficient
flexibility so the requirements can be amended to take account of
any changes in market activity in the future. Given the ongoing
and rapid development in the conduct and structure of financial
markets, the regulations may also allow for the disclosure regime
to be targeted to particular areas in the future.
Option three: Direct disclosure of covered short sales to the market
operator
94. This involves placing a direct obligation on investors to disclose
covered short sale transactions to the market operator. As
discussed under option two, this requirement would be implemented
through the Corporations Act supported by supplementary regulations
covering the technical aspects of the disclosure requirement.
Option four: Disclosure of stock lending transactions
95. This involves requiring disclosure of all stock lending
transactions on the grounds that it is a sufficient proxy for the
level of covered short selling activity in a particular security.
Similar to options two and three above, this option could be
implemented through the Corporations Act supported by supplementary
regulations.
Option five: Review existing short selling regime
96. This involves a wholesale review of the regulatory framework
governing all short selling transactions (both naked and covered).
This review would cover the existing rules relating to short sales
in the Corporations Act.
Assessment of impacts
Option one: Retain the status quo (no regulatory action)
97. This option has the benefit of imposing no additional regulatory
costs on businesses. However, it will not address the current
issues caused by the uncertainty in the market place regarding the
level of covered short selling activity. There is no incentive for
investors to disclose this information to the market. In addition,
there is little capacity for the Government to encourage investors
to voluntarily disclose this information particularly in
circumstances where short selling activity is being driven by
foreign investors. This means that without some level of
Government intervention in the market, this information is unlikely
to be disclosed.
Option two: Direct disclosure of covered short sales to brokers
98. This option has the benefit of ensuring the market is fully
informed regarding the actual level of covered short selling
activity. As discussed above, the removal of the current level of
uncertainty surrounding short selling activity will benefit the
market by promoting greater market confidence, increasing the
information available to investors and assisting regulators to
identify potential market abuse.
99. Targeted consultation with stakeholders has indicated that the
implementation of this option is likely to impose costs on market
participants, particularly the market operator (ASX) and brokers.
The ASX will need to amend its trading system for Australian
securities to facilitate the reporting of covered short sales by
brokers. This will also require the systems used by brokers to
process sales transactions to change so that it is in line with the
ASX trading system. In addition, they may be required to amend
other trading systems they offer investors for example direct
market access systems. This will be particularly relevant for
those brokers that are not currently reporting naked short sales to
the ASX. The extent of these costs and the proportion of brokers
that will offer their clients the ability to execute covered short
sales are currently unknown. The extent of any changes to systems
is only likely to be known once the precise details of the
disclosure regime are settled through any supplementary
regulations.
100. For investors, the cost of reporting covered short sale
transactions to their broker will depend on the size and complexity
of their operations. For individual investors, the costs should be
relatively minimal. However, for larger companies, particularly
those with multiple trading desks, the costs could be significant.
This is because different trading desks within the company may be
taking different positions in the same security at the same point
in time. The potential for simultaneous trading activity in the
same security by different parts of the company makes it difficult
for companies to know whether they are long or short a particular
security on a real time basis. This situation can be further
complicated when the company acts as both a broker and an investor
(for example, an investment bank). Stakeholders have indicated
that these costs become less significant in situations where
reporting of covered short sale transactions is delayed. The
timing of any disclosure requirement under this option would be
determined through the supplementary regulations.
101. In addition, some investors have expressed concerns surrounding the
potential loss of confidentiality regarding their trading
activities. It is intended that the disclosure regime would only
result in the reporting of aggregated data, so individual trades
cannot be identified. However, there may be indirect information
leakage when the investor reports the trade to their broker (for
example, by the broker disclosing this information to other
investors). The potential costs associated with any loss of
confidentiality will be influenced by the timing of the disclosure.
For example, if disclosure is required at settlement rather than
when the order is executed, the costs associated with the loss of
confidentiality is reduced. However, the information will be less
useful to investors if only delayed disclosure is required.
Decisions regarding the timeliness of reporting obligations will be
settled through any supplementary regulations.
Option three: Direct disclosure of covered short sales to the market
operator
102. As this option also results in the full disclosure of covered short
sales, it will have the same benefits as option two outlined above.
The primary difference between this option and option two relates
to the incursion of regulatory costs.
103. Relative to option two, this option imposes less of a regulatory
burden on brokers. This is because investors will no longer be
required to report covered short sales to their broker. However,
it is expected that it would impose a significantly greater
regulatory burden on the market operator and investors. In
relation to the market operator, it is expected that the
implementation costs would be significantly greater if they receive
the information directly from investors rather than through brokers
as proposed under option two. This is because the market operator
will need to establish processes and systems for this reporting of
information directly from investors. In contrast, under option
two, the market operator would be able to take advantage of
processes and systems already in place for the reporting of
information between brokers and the market operator.
104. Investors will also be required to make significant changes to
their processes and systems to facilitate the reporting of this
information directly to the market operator. These would be in
addition to the costs for investors identified under option two in
relation to determining their exposure on particular securities.
However, a relative advantage of this option over option two for
investors relates to confidentiality. In particular, by requiring
this information to be reported directly to the market operator
(rather than through a broker), there is a significantly reduced
chance of information leakage regarding individual trades. As
discussed under option two, the costs to investors associated with
this loss of confidentiality will be largely influenced by the
timing requirements placed on disclosure which will be determined
through any supplementary regulations.
105. It is expected that the additional costs incurred by investors and
the market operator under this option will be greater than the
costs incurred by brokers under option two. This is because there
are a smaller number of brokers (relative to investors) and the
extent of change necessary to the systems will be less as brokers
are already required to report information of a similar nature to
market operators.
Option four: Disclosure of stock lending transactions
106. The benefit of requiring the disclosure of stock lending
transactions is that it would provide information to the market
that could act as a proxy for the level of short selling activity
in Australian securities. However, as noted above, some
stakeholders have questioned whether stock lending data will
provide a sufficient indication of short selling activity given
stock lending transactions are used for a range of other purposes
in addition to short selling. Given this, disclosure of stock
lending alone is unlikely to fully address the uncertainty in the
market relating to the activities of short sellers.
107. The implementation of a stock lending regime will involve some
regulatory costs for investors that would be required to report
these transactions. In particular, the Government understands that
IT infrastructure changes would almost certainly be needed to
facilitate the reporting of this information to the securities
settlement systems. Industry has informed the Government that the
costs of making these changes will be influenced by the service
agreements individual participants have with vendors. However, the
total regulatory cost of implementing these changes is likely to be
less than the regulatory costs associated with options two and
three.
Option five: Review existing short selling regime
108. It has been a number of years since there was a comprehensive
review of the short selling regime in the Corporations Act. A
review of the existing regime would assist in ensuring the
regulatory requirements reflect current market conditions and
trading behaviour. While a review of the existing short sale
review may be useful in the long term, it will not assist in
resolving any of the uncertainty surrounding short sales in the
near term. In addition, implementing a disclosure regime for
covered short sales prior to the commencement of a more general
review of regulatory arrangements would allow the information
resulting from the disclosure regime to inform the review and lead
to a more effective regulatory outcome.
Consultation
109. To date, the Government has engaged in targeted consultation with
stakeholder groups regarding the disclosure of short sales.
Discussions at this meeting focused on identifying current market
practice, the scope for additional disclosure of covered short
sales and the likely impact on industry of any regulatory change.
This includes meetings with ASIC, the Association of Superannuation
Funds of Australia, Australasian Investor Relations Associations,
Securities and Derivatives Industry Association, Australian
Shareholders' Association, Australian Securities Lending
Association, Australian Financial Markets Association, Investment
and Financial Services Association, the Alternative Investment
Management Association and the ASX. These meetings were high level
in nature and did not seek specific comments from stakeholders on
each of the options identified above. However, the feedback from
these meetings, in particular as it relates to possible
implementation costs for investors and brokers, has been drawn on
to develop the impact analysis section of this paper.
110. In addition, the ASX issued a consultation paper on short selling
in April 2008. The Government considered the submissions received
by the ASX on this paper as part of developing and considering its
options for reform in this area. Submissions were received from a
broad range of stakeholders including institutional investors,
brokers, investment banks and investor associations. The ASX has
not made these submissions publicly available.
111. The Government will also engage in public consultation by exposing
draft legislation for public comment of any regulatory option
adopted. This will ensure the views of the wider public are taken
into account on this issue.
Conclusion and recommended option
112. This document outlines a range of possible policy options relating
to the regulation of covered short sale transactions. Options
considered include:
. no regulatory response;
. disclosure of covered short sales by investors to brokers;
. direct disclosure of covered short sales by investors to
the market operator;
. disclosure of stock lending transactions; and
. review of the existing short sales regime.
113. Based on the impact analysis outlined above, option two has been
selected as the recommended approach. Under this option, investors
that enter into covered short sale agreements will be required to
disclose this transaction to their broker. Technical aspects of
the disclosure requirement, for example the timing of disclosure
and whether disclosure of transactions is on a net or gross basis,
will be specified through supplementary regulations (still to be
issued).
114. Implementation of option two will result in the actual level of
covered short selling in a particular security being disclosed to
the market. This will provide confidence to investors and also
facilitate the identification of market abuse by regulators.
However, it is recognised that this option will involve some
regulatory costs, particularly by brokers and large investors that
are required to update their existing systems to facilitate
reporting of covered short sale transactions. While the precise
amount of these costs cannot be determined until the technical
aspects of the disclosure requirement is settled, it is expected
that the regulatory costs associated with this option is less than
what would result from the adoption of option three. The remaining
options fail to sufficiently address the identified issue because
they would still result in uncertainty surrounding the actual level
of short selling activity in Australian securities.
Implementation and review
115. The Government is conscious of the need to effectively engage with
industry to ensure the preferred approach is implemented in a way
that minimises regulatory costs. The first stage in this process
will be to consult with industry on the technical aspects of the
disclosure requirement as part of developing the supplementary
regulations. By specifying these issues by way of supplementary
regulation, the regime will have sufficient flexibility to adjust
to changes in trading behaviour of investors in the future and the
conduct and structures of financial markets. Following this, a
transitional period is likely to be offered to allow brokers
sufficient time to make the necessary changes to their IT
infrastructure in order to enable reporting of these transactions.
116. As the regime will be implemented through the Corporations Act,
ASIC will be responsible for monitoring compliance behaviour of
investors and brokers and taking enforcement action where
appropriate. The Government will also continue to monitor the
application of the regime to ensure that it is operating
effectively. The Government intends to formally review the
measures once they have been in operation for two years.
Do not remove section break.
Schedule 1: Amendments commencing on Royal Assent
|Bill reference |Paragraph |
| |number |
|Item 1 |2.7, 2.8 |
|Item 2 |2.10, 2.13 |
Schedule 2: Amendments commencing on the 28th day after Royal Assent
|Bill reference |Paragraph |
| |number |
|Items 1, 4 and 5 |3.13 |
|Items 2 and 3 |3.10 |
|Item 2 |3.9, 3.11, |
| |4.33 |
Schedule 3: Amendments commencing on Proclamation
|Bill reference |Paragraph |
| |number |
|Items 1 and 2 |4.49 |
|Item 3, subsection 1020AA(1) |4.21, 4.23, |
| |4.24 |
|Item 3, subsection 1020AA(2) |4.22 |
|Item 3, subsection 1020AB(1) |4.25 |
|Item 3, paragraph 1020AB(1)(a) |4.26 |
|Item 3, paragraph 1020AB(1)(b) |4.26 |
|Item 3, paragraph 1020AB(1)(c) |4.26 |
|Item 3, subsection 1020AA(4) |4.27 |
|Item 3, subsection 1020AA(1) and paragraph |4.28 |
|1020AB(1)(b) | |
|Item 3, subsection 1020AA(3) |4.29 |
|Item 3, subsection 1020AB(3) |4.30 |
|Item 3, subsection 1020AB(4) |4.31 |
|Item 3, subsection 1020AB(2) |4.34 |
|Item 3, section 1020AF |4.35, 4.47 |
|Item 3, paragraph 1020AC(1)(a) |4.36 |
|Item 3, subsection 1020AC(2) |4.37 |
|Item 3, subsection 1020AC(3) |4.38 |
|Item 3, subparagraph 1020AD(1)(a)(i) |4.40 |
|Item 3, subparagraph 1020AD(1)(a)(ii) |4.40 |
|Item 3, subparagraph 1020AD(1)(a)(iii) |4.40 |
|Item 3, subsection 1020AD(2) |4.41 |
|Item 3, section 1020AE |4.44 |
|Item 3, subparagraph 1020AB(4)(a)(ii) |4.47 |
|Item 3, subparagraph 1020AB(4)(b)(ii) and |4.47 |
|paragraph 1020AC(3)(b) | |
|Item 3, section 1020AD |4.47 |
|Item 3, subparagraphs 1020AB(1)(d)(i)(ii), |4.47 |
|1020AC(1)(b)(i)(ii)) and 1020AD(1)(b)(i)(ii)| |
|Item 3, subparagraphs 1020AB(1)(d)(iii), |4.47 |
|1020AC(1)(b)(iii)) and 1020AD(1)(b)(iii) | |
|Item 3 |4.20 |
|Item 4 |4.50 |
|Item 5, subsection 1200F(1) |4.51 |
|Item 6 |4.33, 4.39, |
| |4.43, 4.46 |
Do not remove section break.
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