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Regulatory Spotlight: ESMA Guidelines on Economic Ownership

The common English saying, “possession is 9/10ths of the law” can often be applied when facing small, everyday challenges such as, “Who really booked this meeting room for 3:00 p.m.?” Those sitting in the room tend to win the argument. The European Securities and Markets Authority has been looking hard at the concept of ownership in developing its new regulations on short selling, known as SSR.


The crux of the matter rests on what exactly constitutes a naked short sale; if you own something and then sell it, by simple definition this is not a naked short. However, on first pass, ESMA’s draft SSR indicated that the sale of a lent security would constitute a naked short sale – meaning trouble for the seller. Looking further into the implications of defining ownership brought custodian nominees and the exercising of options and futures into the analysis.

It seems that ESMA has done its homework, and its new Technical Advice on Short Selling has clarified many issues.

  • Economic ownership: looking at the disparity of ownership definitions across the EU, ESMA has had to find a common approach to fit the lending market. For example, in some states, the legal title passes on the trade date and others only once the security has actually settled in the buyer’s account. In order to solve this, ESMA has determined that the beneficial owner can have an “economic ownership” for the purposes of the SSRs. This clears the way for buyers of securities to sell those assets prior to their delivery without constituting a naked short. The impact of such legislation, if unchecked, would have meant no one could sell a security he had bought until it had actually been delivered, creating a massive impact on market liquidity.
  • Sale of a security that is on loan: it is common practice for lenders to have automated mechanisms in place to swap or recall shares on loan when the beneficial owner sells them. When recalled on the trade date, the shares are returned (or swapped with another lender account) in time for the settlement date in all but a small minority of cases. In more complex markets, buffers of unlent stock might be held as additional insurance. However, as a loan (or repo) is actually a sale of the asset, the lender is no longer the registered owner and is technically at risk of selling something that he doesn’t own. Clarification on this point now excludes lent securities from this definition as it has been recognized that the beneficial owner retains “economic ownership” of the security while the asset is on loan.
  •  Exercising options and futures: where such instruments can be exercised and the underlying securities are delivered in time to settle the agreed sale, then they will not constitute a naked short sale.
  • Nominees: for economic and administrative reasons, securities are often held in nominee companies and omnibus accounts. Strictly speaking, the ownership of the securities lies with the nominee company, not the actual investor. As such, if the investor sells a security, he is, technically speaking, selling something of which he himself has no legal ownership. Again, the concept of economic ownership has been applied to clarify the situation.

Unintended consequences are a very serious risk when new legislation is being drawn up, and that risk is often greater when regulations must be written in a hurry. The objective of protecting the investor and the marketplace from naked shorting is an admirable one, but sometimes rules meant to make the market more efficient risk doing more damage than good. It is positive to see that ESMA has provided these securities lending clarifications which should hopefully bring the rules back in line with the original aims without harming the markets they seek to protect.


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