ESMA cements its powers, as EU court defeats UK appeal against new short selling rule

ESMA already introduced severe restrictions on short selling, such as banning Naked Shorts

European bureaucrats have scored a decisive victory over the UK’s challenge of financial laws today. The European Court of Justice has released a ruling against limiting the powers of the European Securities and Markets Authority (ESMA) to restrict short selling of certain financial instruments. In its ruling, the Court stated that current EU law is not violated by the ban and all pleas by the UK have been rejected.

It was all the way back in September 2008 when the SEC and national European authorities have banned the naked short selling practice, which itself was a controversial topic way before Lehman Brothers blew up. Banning naked short selling overall is a completely different story – shares are being borrowed from a counterparty in this transaction and the trade is hence “covered”.

There have been many studies on the effects of the bans imposed in 2008, and most of them that we are aware of have concluded that the only effect short selling bans had on the market was increased spreads in the assets traded and decreased liquidity, which in turn lead to increased volatility. Sources are quite respectable – The New York Fed, Journal of Investment Management and The University of Gothenburg.

Significant deterioration in the quality of liquidity seems to be a fact of life, however European bureaucrats prefer to blame the market when financial system risks increase, so they have devised their “backstop” to stressful market conditions.

The UK’s FSA (predecessor to the FCA) itself banned short selling back in December 2008 for a couple of months. UK authorities seem to have drawn some conclusions from their action at the time, which unfortunately is not the case with European bureaucrats.

Apparently as of this point in time the discussion is closed and the ESMA will continue wielding the power to ban short selling in adverse financial markets conditions regardless of the negative consequences on overall market liquidity and increased spreads that it causes. For the latest news about financial markets regulations in the Euro Zone and beyond stay tuned to LeapRate.

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