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ESMA review of short selling regulation handed to EC

The European Securities and Markets Authority (ESMA) has handed its review evaluating the impact of the increased regulation of short selling and certain aspects of credit default swaps (CDS) on European financial markets to the European Commission (EC) ahead of its full report later this month.

ESMA was responding to an EC request for technical advice to inform its report to the European Parliament and Council about the impact of the regulation, which restricted short selling and CDS trading, due by the end of this month.

The advice was requested shortly after the implementation of the short-selling/CDS regulation on 1 November 2012 last year. There were limits to the market data available at the time, and limited regulatory experience in supervising the regulation’s requirements to draw upon, so ESMA was tasked with reporting back.

ESMA’s report makes a number of recommendations that would help to improve how the regulation works in practice moving forward, with the overall recommendation that the regime be re-assessed at a future date when more data and experience have been accumulated added at the end; perhaps suggesting the full impact of the restrictions are still not known, although a certain lessening of liquidity is inevitable.

Given the review’s limitations, its key findings so far about the regulation’s impact on European market conditions are as follows:

• There have been mixed effects on the liquidity of EU stocks, with a slight decline in volatility, a decrease in bid-ask spreads and no significant impact on traded volumes. Price discovery speed appears to have decreased compared to the period before the entry into force of the regulation.
• Overall, settlement discipline has improved.
• No compelling impact on the liquidity of EU single name CDS and on the related sovereign bond markets could be noticed, except in a few countries. The liquidity in European sovereign CDS indices has been somewhat reduced.