Clause 13

Financial Services Bill – in a Public Bill Committee at 12:00 pm on 12 January 2010.

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Power of FSA to prohibit, or require disclosure of, short selling

Question proposed, That the clause stand part of the Bill.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I do not want to say a huge amount about the clause. There was some discussion at the evidence sessions about whether the clause was needed, because similar paths had been taken by the FSA during the financial crisis to tackle some of the issues relating to short selling of certain banks’ shares. It was argued that the FSA took action under its market abuse powers and that that was not appropriate. Indeed, the British Bankers Association said:

“Our members consider that it is inappropriate that the FSA’s current rules on the emergency restriction of short selling sit within the market abuse rules of the FSA handbook. Rather, it would be better for them to be moved to the disclosure rules. The placement of generalised rules on short selling into the market abuse rules wrongly associates all forms of short selling with abuse.”

The CBI echoes that. It says:

“The previous temporary measures adopted by the FSA in respect of short selling were taken under the market abuse regime partly because the FSA believed it had no other power to act.”

We welcome the fact that it is now put on a formal basis, although it still sits within the part of the Financial Services and Markets Act 2000 that relates to market abuse. It has not gone all the way in tackling the concern that the BBA has.

The Minister has defended short selling on a number of occasions on the Floor of the House—once in response to a question by my hon. Friend the Member for Macclesfield (Sir Nicholas Winterton). The Minister is a very clear opponent of that form of trading in markets. Of course, it can give rise to a number of issues. The impact assessment characterises the problems with short selling. It can lead to three aspects of market failure: market abuse, disorderly markets potentially leading to a depositor run, and transparency deficiencies. It was around the issue of disorderly markets that such changes were largely introduced.

We do not, therefore, have an issue with the introduction of part 8A, but I do want to raise a question about the wording of proposed new section 131B(1). My assumption is that the Government are seeking to prevent the short selling of certain financial instruments, such as the shares of Barclays bank, HSBC or the Royal Bank of Scotland. However, it is not entirely clear from subsection (1) whether that is the full limit of their ambitions, because it states:

The Authority may make rules prohibiting in specified cases persons from engaging in short selling”.

I am not sure whether that means that the Government would like to stop an institution short selling. They might tell a particular hedge fund or investment manager to stop short selling, rather than saying that they want to stop the short selling of a particular financial instrument. Will the Minister clarify that, because it would seem odd for the rules to focus on stopping one institution from engaging in short selling rather than applying across the market? If that is the Government’s intention,  they could use powers elsewhere in the Bill instead. I would be grateful for some clarity on that aspect of the rules from the Minister.

Photo of John Howell John Howell Conservative, Henley 12:15, 12 January 2010

I have three issues on the clause. The first is the definition, the second is the clarity of the proposals and the third is the relationship with the international regime.

There has not been a legal definition of short selling to date, so the Bill sets a precedent. The Committee will recall the evidence session at which Simon Gleeson of Clifford Chance said that the Bill provides

“a basis for banning selling. The definition of short selling, as set out in the legislation, is any transaction in which someone might benefit if the value subsequently goes down.”——[Official Report, Financial Services Public Bill Committee, 10 December 2009; c. 105.]

It was commented that the proposals were more akin to banning selling than short selling. That witness session revealed a wish for a more thoughtful definition. There was an acknowledgement that it was difficult to define short selling. The lawyers offered us the opportunity to have a paper providing more evidence regarding what a definition might look like. I am not sure whether anything has yet emerged, but it would be useful to pursue it, because there is concern that, by common consent, the definition in the Bill still needs to be fleshed out. My question, therefore, is how the definition will be taken forward, given the concern about it among such distinguished lawyers.

On the clarity of the proposals, the clause proposes two things—emergency powers to stop short selling, which is largely separate from abuse, although linked to it, and a disclosure regime. To look first at the stopping part of the proposals, my hon. Friend the Member for Fareham made a valid point, which was also made by the British Bankers Association, when he asked what the purpose of the proposals is. Is it to allow the FSA to suspend trading and stop activity in a certain instrument or is it to stop certain firms from undertaking such activity?

The FSA accepts that regulatory intervention is justified where there are identified market failures and it is expected to deliver net benefits to the market, and I see no disagreement about that. However, that means that we need—the CBI has called for this—to know more about the circumstances in which the provisions will be used and how they will be used, given that the Bill is aimed principally not at abuse, but at disorderly markets and transparency deficiencies. It is relevant to link that to the assessment in the discussion paper that the FSA produced on the issue almost a year ago. That paper looked at six options, of which the stopping of the selling only when there was an urgent need was the one that eventually came through into the Bill. However, the circumstances need to be better defined because they were not well defined in the document. Will the Minister comment on the balance that we need between recognising the benefits of short selling—an increased number of sellers, improved liquidity, increasing trade volumes and reducing the transaction costs and overall improvements in efficiency—and the specific problems that occur in disorderly markets where there is an excess of volatility that can lead to contagion.

The FSA document also pointed out that emergency measures themselves may lead to additional volatility just because they have had to be taken and brought into  use. Therefore, something about the circumstances that justify the imposition of this measure would help.

Let me repeat again that the FSA accepts that regulatory intervention is justified when there are identified market failures and when it is expected to deliver net benefits to the market. Paragraph 3.17 states:

“It is not clear whether a lack of transparency about the level of short-selling and the identity of short sellers gave rise to a material market failure. Further there is the question whether the benefits of any mandatory disclosure requirements exceed the cost.”

However, what evidence is there that disclosure will be useful in normal market situations and will improve stability in volatile times? The FSA document is principally considering market abuse, but we need to extend beyond that. A process needs to take place in relation to the costs involved. I did not mean to be entirely glowing about the range of benefits that is put in here. A process seems to be under way of bringing the number down. I was struck by the way in which the impact assessment does not take into account opportunity costs because they were unable to be quantified. They may be unable to be quantified, but they are certainly not equal to zero, so a process needs to take place in relation to that.

Another issue that I wanted to raise was the relationship with the international regime. The Treasury has already admitted that the UK currently has a wider definition of market views that many of its European counterparts. Paragraph 5.2 of the FSA documents states:

“We know that market participants have encountered problems and significant costs in having to comply with the variety of different regimes introduced in the relevant jurisdictions.”

There have also been calls for the regime to be applied as widely as possible internationally. In February, the International Organization of Securities Commission and the Committee of European Securities Regulators had working parties on short selling with the aim of trying to produce a draft law by the end of 2009. It will be good to have an update on that. The issue is not consistent across the European Union. David Ereira in his evidence session said that no assurances could be given that what is being proposed in this clause will dovetail into the EU, and that the UK was jumping the gun. He said:

“It will probably work out all right, because the wording is sufficiently wide that in all probability we will be able to come up with appropriate regulations that fit within whatever comes out of the international processes. It just seems to me more appropriate to wait and see what comes out of those international processes”.——[Official Report, Financial Services Public Bill Committee, 12 January 2010; c. 110, Q48.]

If we look at how prominent members of the European Union have dealt with the issue over the past few months, we get a varied pattern. Austria saw it as abuse and linked it to market manipulation and insider trading. Belgium linked it to good order, integrity and transparency and introduced rules that are restrictions on the vending of shares. The Czech Republic took no action. Denmark’s ban applies to short selling in financial companies. Finland went for more supervision. France aimed at short selling of financial sector securities and Germany principally banned naked short selling of specific financial institutions. That is a hugely disparate approach, and one can completely understand where the lawyers who spoke in the evidence-taking sessions were coming from when trying to get to grips with the difficulties that  companies face with this, and the need for consistency. I hope that the Minister will provide some clarification on those issues.

Photo of Ian Pearson Ian Pearson Economic Secretary, HM Treasury

Indeed I will. Let me set out the purpose and thinking behind the clause before addressing the comments made by the hon. Members for Henley and for Fareham. In clause 13, we are trying to give the FSA the power to control all forms of short selling that might threaten financial stability in the future. As has been demonstrated, the FSA already has the power to control short selling, but under its existing powers it can do that only when it considers that short selling amounts to market abuse. Certain short selling activities—which legally cannot and should not be characterised as market abuse—might nevertheless give rise to disorderly markets and create risks to financial stability. That is why new part 8A gives the FSA the power to control short selling, so as to protect the stability of the financial system and maintain confidence in it.

Responses to our public consultation showed overwhelming support for allowing the FSA to place clear and independent restrictions on short selling, and to require the disclosure of short selling. Under certain circumstances, the FSA would be able to ban short selling in certain financial instruments, such as shares in a particular bank. In response to the hon. Member for Fareham, let me take the opportunity to clarify that the powers would not enable the FSA to ban an individual firm from short selling a stock when another firm was able to continue doing so.

The FSA expects to use the power to prohibit short selling infrequently. As is known, it last used this power in a time of extreme market turbulence when there was high and prolonged price volatility and downward pressure on the price of financial stocks. By giving clear, separate, independent powers in legislation other than that relating solely to market abuse, we give clarity to firms about the scope of the FSA’s powers, and why it has those powers—again, I emphasise that it is to protect the stability of the financial system and to maintain confidence in that system.

The FSA will have the power to fine or censure persons who breach short selling rules. That extends to all people who engage in short selling, including those who are not authorised persons under FSMA. Allied to that, the FSA will be able to require the production of information and documents from a person—or persons connected to a person—suspect of having contravened those rules. These are straightforward enforcement powers, and it is not unusual for such powers to extend to unauthorised persons in that way, as is the case with the market abuse regime.

The hon. Gentleman made the point that we are putting short selling powers in the market abuse rules section. I have said this already: we are introducing a new part 8A. Although it will follow part 8 of FSMA, which contains provisions on market abuse, it is entirely separate from it. The new powers given in part 8A will not be dependent on provisions in part 8; part 8A is located after it, but it is entirely separate. Without being too controversial, let me draw an analogy with the measure that allowed us to take action against Iceland. That featured in a Bill with a long title that included the word “terrorism”, even though the actions we took were about protecting consumers. I shall not speak any further on that matter.

The hon. Member for Henley said that there was no proper definition of short selling, and went on to give a number of international examples of where other countries have taken action on short selling. We pretty much know what we mean when we talk about short selling, but the FSA will obviously consult on the definition that is to be included in its rules.

On the point that the hon. Member for Henley made about disclosure, there is a global regulatory consensus that requiring disclosure on short positions is a good thing and will help reduce the potential for abusive behaviour and disorderly markets, so it is important to implement it. He also asked about the relationship to EU rules. The powers given to the FSA in the Bill will enable it to implement any new EU rules on the matter.

It is not possible to specify in detail what future circumstances might require the introduction of an emergency ban. It is essential not to fetter the FSA’s discretion to take action in conditions that might require swift intervention. However, when using the proposed emergency powers, the FSA would need to be satisfied that its rules were necessary to maintain confidence in or protect the stability of the UK financial system. For example, if short selling threatened to destabilise an institution or institutions whose failure could have systemic effects, or if short selling were otherwise leading to a widespread loss of market confidence, it would be appropriate for the FSA to act.

The clause is important. It has been helpful to have this stand part debate in order to put certain matters on the record. I commend the clause to the Committee.

Question put and agreed to.

Clause 13 accordingly ordered to stand part of the Bill.