Regulatory Corner

Regulatory Corner

Volatility accelerates calls for market reform in Europe

The emergence of market volatility in European public debt markets during the second quarter led to intensified calls for regulators to take swifter action on market reform measures that had been progressing steadily since the crisis first broke in 2008.

As reported last quarter, the Committee of European Securities Regulators (CESR) proposed a Pan-European short selling disclosure regime in March 2010. The incoming Commissioner for the Internal Market, Michel Barnier, recognized short selling, including the treatment of credit default swaps, as a priority for EU action and aimed to consult before the summer with the goal of putting forward a legislative proposal towards the end of 2010.

However, faced with the euro-zone market volatility reported in this quarter’s Market Update, senior politicians lent their weight to calls for urgent market reform.  In a joint letter to José Manuel Barroso, president of the European Commission published on

June 10 2010, French president Nicolas Sarkozy and German chancellor Angela Merkel said severe turbulence on financial markets in recent months had raised deep concerns among national governments and the public. The French and German leaders commented that the return of high market volatility raise questions specifically about certain financial ‘techniques’ and the use of certain derivative products, such as short-selling and credit default swaps.

Although the European Commission committed in it’s response to bringing forward ‘concrete proposals’ on short selling during the summer, some regulators took unilateral measures in the meantime. In April the Greek regulator reintroduced its ban on short selling of securities traded on ATHEX while, in May, the German regulator introduced an immediate ban on naked short selling of financial stocks and euro-zone sovereign bonds.

Proposals announced in June by the Finance Commission of the French National Assembly to reduce the securities settlement cycle in France from three days to one (“T+3” to “T+1”) in a bid to prevent short selling were criticized by the Association for Financial Markets in Europe (AFME) which commented that, “This proposal would increase operational risk and fragmentation in Europe while bringing no practical benefit and could result in a number of unintended negative effects.”

EU short selling consultation published

In June, the European Commission published its consultation paper on possible measures on short selling and credit default swaps (CDS), focusing on new transparency rules, restrictions on naked short sales to address settlement risk and emergency powers. The paper made specific proposals to introduce the two-tier disclosure regime proposed by CESR in relation to net short positions in EU shares, but extending this to require private (but not public) disclosure to regulators of net short positions in EU government bonds. It also proposed a general ban on naked short selling of EU shares and buy-in procedures for unsettled short sales in those shares. National regulators will be given new emergency powers to ban or restrict short selling of EU shares and bonds and EU sovereign linked CDS, subject to co-ordination by the proposed new European Securities and Markets Authority (ESMA).

J.P. Morgan contributed to the detailed industry response to the consultation which is available here.

With respect to the U.S. regulatory front, and, in specific response to the acute systemic risk that ensued in the markets following the 2009 crisis, the Federal Reserve asked market participants to convene and develop recommendations for improving the stability of the underlying infrastructure of the Tri-Party Repo market.

J.P. Morgan assumed a leadership role on the Fed’s Task Force and helped shape policy in this arena.  The firm worked with other market participants to successfully develop and recommend significant improvements in the industry’s best practices, particularly in the areas of intra-day credit arrangements, dealer liquidity risk management, margining agreements and contingency planning.

With respect to intra-day credit, J.P. Morgan not only helped lead and shape needed enhancements in the Tri-Party Repo market, we also saw an opportunity to  develop and launch a ground-breaking new platform and functionality – Auto Substitution -  that provides new options for dealers and investors to maintain true term exposure to the counterparty with which they have contracted. 

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