Ignorance is not bliss - a timely reminder that derivatives ARE included! • Funds-Axis Limited

Yesterday, the Financial Conduct Authority (FCA) fined a Hong Kong hedge fund just over £870,000 for failing to disclosure its net short position in Premier Oil Plc. This is the first time the FCA has taken enforcement action for a breach of the SSR.

Asia Research and Capital Management Ltd (ARCM) agreed to resolve the matter and qualified for a 30% discount under the FCA’s executive settlement procedures. Were it not for this discount, the FCA would have imposed a financial penalty of £1,247,312.25 on ARCM.

Between February 2017 and July 2019, ARCM built a net short position equivalent to 16.85% of the issued share capital in Premier Oil, which is one of the largest short positions in UK history. Compare that to today’s public short positions disclosed to the FCA, and the next largest is a short position of 4.64%, a hefty short position dwarfed by the position previously held by ARCM.

The fine is a timely reminder of the importance of understanding the correct rules in jurisdictions across the globe, in particular, as with where ARCM fell short, in establishing and tracking which securities are deemed in scope for short selling.

Obligations under the EU Short Selling Regulation

In the EU, the Short Selling Regulation (SSR) imposes obligations on all market participants trading in financial instruments for which the Authority is the relevant competent authority, wherever they are domiciled or established.

The SSR applies to any transferable security such as shares. It also states that a short position includes a transaction related to a share which gives the effect of conferring a financial advantage on the person entering into it in the event of a decrease in the price of the share. This would include derivatives such as equity swaps and contracts for difference relating to shares which replicate the effects of a short sale of the share itself. This is in contrast to regimes in non-EU jurisdictions which often exclude derivatives, in particular, cash settled derivatives.

For the purpose of the SSR, a net short position in relation to shares of an issuer is the position which results from the difference between any short position and any long position held by a market participant in relation to the issued share capital of an issuer.

Where a market participant holds a net short position in a share admitted to trading on any trading venue in the EU, it has the following obligations:

If the net short position is equivalent to 0.2% of an issuer’s issued share capital, it must report this to the Authority;
For every increase of that net short position equivalent to 0.1% of an issuer’s share capital, it must make a further notification to the Authority;
If the net short position is equivalent to 0.5% of the issuer’s share capital, it must be made public, through publication on a website maintained by the Authority. In practice, this requires the market participant to make the notification to the Authority; and
For every increase of that net short position equivalent to 0.1% of an issuer’s share capital, it must make further disclosure to the public via its notification to the Authority.

NB. ESMA currently has measures in place requiring holders of net short positions to notify the relevant national competent authority (NCA) if the position reaches or exceeds 0.1% of the issued share capital. The measure applies from 18 September 2020 for a period of three months.