ASIC RG 196 — ASIC Regulatory Guide – RG 196 Short selling

Page 1 REGULATORY GUIDE 196 Short selling October 2018 About this guide This guide contains an overview of the short selling provisions of the Corporations Act 2001 and the Corporations Regulations 2001 as they relate to securities, managed investment products and certain other financial products. In particular, it addresses the naked short selling prohibition and the reporting and disclosure obligations. This guide is particularly relevant to institutional investors and brokers who are involved in short selling activity. Page 2 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 2 About ASIC regulatory documents In administering legislation ASIC issues the following types of regulatory documents. Consultation papers: seek feedback from stakeholders on matters ASIC is considering, such as proposed relief or proposed regulatory guidance. Regulatory guides: give guidance to regulated entities by:  explaining when and how ASIC will exercise specific powers under legislation (primarily the Corporations Act)  explaining how ASIC interprets the law  describing the principles underlying ASIC’s approach  giving practical guidance (e.g. describing the steps of a process such as applying for a licence or giving practical examples of how regulated entities may decide to meet their obligations). Information sheets: provide concise guidance on a specific process or compliance issue or an overview of detailed guidance. Reports: describe ASIC compliance or relief activity or the results of a research project. Document history This version was issued on 8 October 2018 and is based on legislation and regulations as at the date of issue. Previous versions:  Superseded Regulatory Guide 196, issued 19 September 2008, reissued 23 April 2010, minor amendments made to the text on 31 May 2010, and reissued 7 April 2011. Disclaimer This guide does not constitute legal advice. We encourage you to seek your own professional advice to find out how the Corporations Act and other applicable laws apply to you, as it is your responsibility to determine your obligations. Examples in this guide are purely for illustration; they are not exhaustive and are not intended to impose or imply particular rules or requirements. Page 3 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 3 Contents A Overview of the short selling provisions ...................................... 4 What is a short sale? ......................................................................... 4 Short selling disclosure ...................................................................... 5 Exemptions and modifications by ASIC ............................................. 6 Significant breach reporting ............................................................... 6 B Naked short selling prohibition ...................................................... 7 The prohibition in s1020B .................................................................. 7 Interpretation of terms in s1020B ...................................................... 7 C Exceptions to the naked short selling prohibition ..................... 10 Exceptions to the naked short selling prohibition ............................ 10 Situations in which naked short selling is permitted ........................ 10 D Short selling disclosure ................................................................ 27 General information ......................................................................... 27 Short sale transaction reporting ....................................................... 28 Examples of short sale transaction reporting .................................. 31 Short position reporting.................................................................... 34 Examples of short position reporting ............................................... 39 Failure to report short sale transactions or short positions .............. 42 Appendix: Consolidated Div 15 of Pt 7.9 of the Corporations Regulations 2001 ........................................................................... 43 Key terms ............................................................................................... 49 Related information ............................................................................... 51 Page 4 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 4 A Overview of the short selling provisions Key points Short selling is regulated by the Corporations Act 2001 (Corporations Act) and the Corporations Regulations 2001 (Corporations Regulations). Short sales are generally referred to as naked short sales and covered short sales: see RG 196.2–RG 196.6. In Australia, covered short sales are permitted: see RG 196.3. Naked short sales are prohibited except where ASIC has given relief: see Section C. If you make a short sale on a licensed market, you may need to comply with reporting and disclosure requirements: see Section D. Failure to report is an offence under s1311: see RG 196.10. What is a short sale? RG 196.1 People sometimes sell (short sell) financial products that they do not own with a view to repurchasing them later at a lower price. Covered short sales RG 196.2 Generally, where a person executes a short sale and relies on an existing securities lending arrangement to have a ‘presently exercisable and unconditional right to vest’ the products in the buyer at the time of sale, the sale of the products is a covered short sale. RG 196.3 Covered short selling is permitted under the Corporations Act. This recognises covered short selling as a legitimate mechanism for price discovery and liquidity, subject to disclosure and subject to intervention by ASIC in exceptional cases. Naked short sales RG 196.4 Generally, the practice of short selling securities without a securities lending arrangement is known as ‘naked short selling’. RG 196.5 Under the Corporations Act, a person must not sell a section 1020B product in Australia if, at the time of sale, the person does not have a presently exercisable and unconditional right to vest the product in the buyer: s1020B. RG 196.6 Naked short sales tend to have a higher risk of settlement failure. This is because the seller has already made the sale but has yet to arrange to have a Page 5 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 5 presently exercisable and unconditional right to vest at the time of sale. There are a number of exceptions to the naked short selling prohibition: see Table 1 in Section C. Short selling disclosure RG 196.7 If a seller makes a short sale on a licensed market, the seller may be required to comply with reporting requirements set out in Div 5B of Pt 7.9 of the Corporations Act and Div 15 of Pt 7.9 of the Corporations Regulations: see the appendix. RG 196.8 There are two separate short selling reporting requirements: (a) short sale transaction reporting: see RG 196.121–RG 196.148; and (b) short position reporting: see RG 196.149–RG 196.193. RG 196.9 These obligations apply to short sales of section 1020B products made on a licensed market, irrespective of whether the seller is in Australia. RG 196.10 Failure to comply with the disclosure requirements is an offence under s1311. Short sale transaction reporting RG 196.11 Short sale transaction reporting is the reporting of daily volumes of section 1020B products that are short sold in the market. RG 196.12 In general, covered short sale transactions must be reported to the market operator: see RG 196.129–RG 196.132 and RG 196.135–RG 196.136. RG 196.13 We have taken a no-action position on naked short selling in certain circumstances. Some of these are conditional on the seller complying with transactional reporting obligations: see RG 196.108–RG 196.110. RG 196.14 Short sale transaction reporting benefits the market because it may explain share price movements and assist regulators in carrying out market surveillance and investigating alleged cases of market misconduct. Short position reporting RG 196.15 A short position in relation to a section 1020B product is where the quantity of the product that a person has, when acting in a particular capacity, is less than the quantity of the product that the person has an obligation to deliver, when acting in the same capacity: reg 7.9.99(2). When a person makes a covered short sale, the person may be required to report their short positions to ASIC: see RG 196.159–RG 196.169. Page 6 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 6 RG 196.16 We have granted exemptions from the prohibition against naked short selling in some circumstances. In many of these cases, the exemption is conditional on short position reporting by the short seller on the same basis as for covered short sales. RG 196.17 We have granted relief exempting sellers from reporting ‘small’ short positions that fall below a reporting threshold: see RG 196.164–RG 196.169 and Table 2 in Section D. RG 196.18 Short position reporting benefits the market because it provides an indication of the level of risk involved in short selling a particular security as well as the market sentiments in that security. Exemptions and modifications by ASIC RG 196.19 We have the power to exempt a person, a financial product or class of persons or financial products from the short selling provisions of Pt 7.9 of the Corporations Act. We may also declare that the short selling provisions apply as if specified provisions were omitted, modified or varied: s1020F. RG 196.20 In this regulatory guide, we have indicated where we have used our powers to modify or grant exemptions from the short selling provisions or to declare that the short selling provisions apply as if specified provisions were omitted, modified or varied. Significant breach reporting RG 196.21 An Australian financial services (AFS) licensee that breaches or is likely to breach the short selling provisions may need to notify us of that breach: s912D. Note: For guidance on breach reporting, see Regulatory Guide 78 Breach reporting by AFS licensees (RG 78). Page 7 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 7 B Naked short selling prohibition Key points ‘Naked’ short selling is prohibited in Australia subject to limited exceptions: see RG 196.24. To avoid breaching this prohibition, a person selling products must, at the time of sale, have a presently exercisable and unconditional right to vest: see RG 196.25–RG 196.40. The prohibition in s1020B RG 196.22 In Australia, a person may only sell ‘section 1020B products’ to a buyer if, at the time of sale, the person has, or believes on reasonable grounds that they have, a presently exercisable and unconditional right to vest the products in the buyer: s1020B(2). RG 196.23 ‘Section 1020B products’ means: (a) securities; (b) managed investment products (including exchange traded funds (ETFs)); (c) financial products referred to in s764A(1)(j) (i.e. debentures, stocks and bonds issued by a government); or (d) other kinds of financial products prescribed by the regulations. Note: For the definition of ‘section 1020B products’, see s1020B(1). For financial products prescribed for the purposes of s1020B(1), see reg 7.9.80B. RG 196.24 A sale of these products, other than as described at RG 196.22, is known as a naked short sale and is an offence under s1311(1) unless it falls within a specific exception: see Table 1 in Section C. Interpretation of terms in s1020B What is ‘at the time of sale’? RG 196.25 ‘At the time of sale’ includes when an offer for sale is placed. RG 196.26 A person is taken to sell section 1020B products if they purport to, offer to, hold themselves out as entitled to, or instruct the holder of an AFS licence to, sell those products: s1020B(7). Page 8 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 8 RG 196.27 ‘At the time of sale’, for the purposes of s1020B(2), is at the point of sale and not at the close of the trading day. For example, a person may enter into any number of transactions throughout a trading day. At the close of the trading day, a person may have purchased the same number or more of a particular security than has been short sold (this is sometimes referred to as a ‘net no sale position’). A person who has a net no sale position at the close of trading would still need to have a presently exercisable and unconditional right to vest at each point in time during the day when a sale is made (in addition to the times referred to in s1020B(7)). What is a ‘presently exercisable and unconditional right to vest’? RG 196.28 The definition of a ‘presently exercisable and unconditional right to vest’ is important for the purposes of determining whether a sale is a naked short sale (and thus prohibited) or a covered short sale (which is permitted subject to reporting and disclosure) or neither (an ordinary sale). Note: See also RG 196.2–RG 196.3 for a discussion on covered short sales. RG 196.29 To have a presently exercisable and unconditional right to vest, a person must, at the time of the sale, have power to direct a transfer of the product; that is, the person must have the absolute ability to give the buyer title to the product. RG 196.30 A person who holds legal title to the product at the time of sale would have a presently exercisable and unconditional right to vest for the purposes of s1020B. RG 196.31 We understand it is common market practice to rely on securities obtained under a securities lending arrangement to satisfy the need to have a presently exercisable and unconditional right to vest the securities in the buyer. RG 196.32 In Australia, securities lending arrangements typically involve the transfer of securities from the owner (lender) to another party (the borrower), with the borrower obliged to return the securities (or their equivalent) either on demand or at the end of the loan term. The borrower usually gives the lender collateral as security for the loan. Note: While securities lending is a sale with an undertaking to return the transferred securities (or their equivalent), this guide uses the common market terminology to describe the transaction and parties. For detailed analysis on the legal characterisation of securities lending arrangements, see Beconwood Securities Pty Ltd v ANZ Group Limited (2008) 246 ALR 361; [2008] FCA 594. RG 196.33 We consider that the borrower will satisfy the presently exercisable and unconditional right to vest requirement if the lender has given the borrower (or a third party as the borrower may direct or procure), at the time of the borrower’s sale, a firm commitment to deliver the products. By ‘firm commitment’, we mean a legally binding commitment. Page 9 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 9 RG 196.34 The best evidence of that firm commitment would be written confirmation for delivery into settlement or transfer. In contrast, an agreement made at the time of the sale for a lender to provide the borrower with securities on a ‘best endeavours basis’ cannot provide a presently exercisable and unconditional right to vest the financial product. RG 196.35 We recognise that arrangements between lenders and borrowers will vary. Whether the arrangements are sufficient to reflect a presently exercisable and unconditional right to vest will depend on the particular circumstances of these arrangements. Conditional hold notices RG 196.36 The use of hold notices is a market practice associated with securities lending, although the practice is not governed or defined in standard securities lending agreements. RG 196.37 A hold notice is an informal arrangement where a prospective lender ‘reserves’ or ‘holds’ securities for, and at the request of, a prospective borrower. Either party can withdraw or terminate the hold notice at any time. The hold notice would typically otherwise lapse within 24 hours or at the end of the trading day. RG 196.38 The hold notice is used by prospective borrowers who do not wish to borrow the relevant securities at that time but wish to retain the potential to do so. For example, a prospective borrower may place a hold for a particular security with a lender while contacting another lender to determine the most competitive borrowing rate for that security. As such, while a hold notice has been given, it will not necessarily result in all or any of the held securities being lent or borrowed under a securities lending agreement. RG 196.39 The market recognises that hold notices are subject to conditions. For example, a hold notice may be cancelled, and therefore is conditional on whether the relevant securities continue to be available for lending at the time the prospective borrower confirms it wishes to borrow the relevant securities. RG 196.40 Given the above, we consider that a hold notice does not provide a seller with a presently exercisable and unconditional right to vest a product in a buyer for the purposes of s1020B(2). A sale made in reliance on a hold notice would be a naked short sale. Furthermore, a prospective lender cannot provide a presently exercisable and unconditional right to vest to a prospective borrower if the prospective lender is itself relying on a hold notice. Page 10 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 10 C Exceptions to the naked short selling prohibition Key points There are a number of exceptions to the naked short selling prohibition: see Table 1. Exceptions to the naked short selling prohibition RG 196.41 We have the power under s1020F to give relief from the naked short selling prohibition. Generally, we will only give this relief to facilitate the orderly operation of markets. To date, we have exercised our power to grant a number of exceptions to the naked short selling prohibition: see Table 1. Note: For more information on how to apply for ASIC relief, see Regulatory Guide 51 Applications for relief (RG 51). Situations in which naked short selling is permitted RG 196.42 Table 1 sets out a summary of the situations in which naked short selling may be allowed, despite the naked short selling prohibition. As noted below, many of these exemptions are granted in the ASIC Corporations (Short Selling) Instrument 2018/745. Some potential exemptions require an application to ASIC for a no-action position: see Regulatory Guide 108 No-action letters (RG 108). Table 1: Summary of situations in which naked short selling is permitted Situation Source/nature of exemption Description Prior purchase agreement s1020B(4) A short sale by a person who:  before the time of sale, has entered into a contract to buy those products; and  has a right to have those products vested in the person that is conditional only on all or any of the following: − payment of consideration; − receipt of the proper instrument of transfer; or − receipt of the title documents. See RG 196.43–RG 196.45. Page 11 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 11 Situation Source/nature of exemption Description Market makers: ETFs and managed funds ASIC Corporations (Short Selling) Instrument 2018/745—Part 2 A short sale of units in certain ETFs or managed funds by a market maker in the course of making a market in ETFs or managed funds. The relief is subject to conditions, including:  the market maker must hold (or be exempt from holding) an AFS licence which authorises it to make a market in the relevant products;  as soon as reasonably practicable after the sale, the market maker must purchase or apply for the issue of equivalent ETF or managed fund units to settle the sale. See RG 196.46–RG 196.52. Market makers: Bona fide hedging ASIC Corporations (Short Selling) Instrument 2018/745—Part 2 A short sale by a market maker to hedge risk from its market-making activities where the shorted product is either:  a security or managed investment product that is a constituent of the S&P/ASX 300; or  an interest in the SPDR S&P/ASX 200 Fund (STW). The market maker must hold (or be exempt from holding) an AFS licence. In addition, at the time of sale, the market maker must believe on reasonable grounds that either:  a securities lending arrangement can be put in place to allow delivery; or  for a shorted product that is an interest in STW, it can acquire or borrow sufficient products to ensure it can deliver all products sold on the day delivery is due. This exemption is subject to further conditions. See RG 196.53–RG 196.60. Exchange traded options: Sales effected by exercising options ASIC Corporations (Short Selling) Instrument 2018/745—Part 2 A short sale resulting from the exercise of exchange traded options (e.g. the exercise of a put option or sale of a call option that is later exercised). See RG 196.61–RG 196.64. Exchange traded options: Sales effected by issuing options ASIC Corporations (Short Selling) Instrument 2018/745—Part 2 A short sale of a financial product that is done by giving or writing certain exchange traded options. See RG 196.65–RG 196.66. Exchange traded options: Unobtained financial products ASIC Corporations (Short Selling) Instrument 2018/745—Part 2 A short sale of financial products where, at the time of sale, the person can obtain at least the number of financial products of the same class by exercising exchange traded options. See RG 196.67–RG 196.68. Page 12 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 12 Situation Source/nature of exemption Description Debentures: Clearing and settlement participants ASIC Corporations (Short Selling) Instrument 2018/745—Part 2 A short sale by a person acting as principal of:  bonds issued by a government; or  bonds/debentures issued by a body corporate if the amount on issue (with the same maturity and coupon terms) exceeds $100 million. However, the seller must believe on reasonable grounds that arrangements can be put in place for settlement by the relevant time. See RG 196.69–RG 196.70. Deferred purchase agreements ASIC Corporations (Short Selling) Instrument 2018/745—Part 2 A short sale of an ASX-listed security or managed investment product (delivery product) as a result of entering into a deferred purchase agreement under which:  the issuer agrees to deliver, at least 12 months after entering into the agreement, the delivery product at a specified time in the future (maturity);  the number and value of the delivery products to be delivered at that time is ultimately determined or derived from the value of a predefined reference asset (e.g. another financial product or asset other than a derivative that relates to the delivery product); and  the issuer has the right in certain circumstances to substitute the delivery product with another at maturity. See RG 196.71–RG 196.77. Conditional and deferred settlement trading: Initial public offerings (IPOs) and other public offers ASIC Corporations (Short Selling) Instrument 2018/745—Part 3 A short sale during a deferred settlement trading period in relation to an IPO. This exemption applies where the seller has an entitlement to be issued with or sold the products under, or in connection with, the public offer. This exception extends to a sale by a person who has entered into a contract to buy these products on a licensed market during a deferred settlement period. This relief will expire at the end of 30 September 2021. See RG 196.82–RG 196.89. Deferred settlement trading following corporate actions ASIC Corporations (Short Selling) Instrument 2018/745—Part 3 A short sale on a licensed market of unissued section 1020B products during a deferred settlement trading period by a person who has an entitlement to be issued the section 1020B products under a corporate action. This exception extends to a sale by a person who has entered into a contract to buy these products on a licensed market during a deferred settlement period. It will expire on 30 September 2021. See RG 196.90–RG 196.96. IPOs: Sale offers through special purpose vehicles ASIC Corporations (Short Selling) Instrument 2018/745—Part 3 A short sale of shares by a special purpose vehicle which has entered into an agreement to purchase the shares from shareholders of a company making an IPO. This exemption applies notwithstanding that the prior purchase is conditional on the company being listed on ASX. This exception is subject to additional conditions. See RG 196.97–RG 196.104. Page 13 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 13 Situation Source/nature of exemption Description Selling before completing a recall of loaned securities AD08-23 A short sale by the owner (seller) of a portfolio of securities or managed investment products placed in an established securities lending program where, at the time of sale, the seller is entitled to recall from the program at least the number of securities or products that are the subject of the sale. No-action position is subject to conditions. See RG 196.105–RG 196.107. Selling CHESS Depository Interests (CDIs) before conversion Individual no- action positions provided on application A short sale of CDIs by a person who has a presently exercisable and unconditional right to vest the underlying securities in a buyer where, as soon as practicable after the sale, the person takes all necessary steps to convert equivalent securities into CDIs of the class sold. No-action position is subject to conditions. Short sales made under this no-action position must be reported to ASX. See RG 196.108–RG 196.110. Client facilitation services Individual no- action positions provided on application A short sale of securities by a stockbroker to a client, in response to the client’s buy order, in the ordinary course of a client facilitation business. No-action position is subject to conditions. See RG 196.111–RG 196.114. Prior purchase agreements RG 196.43 Section 1020B(4) permits naked short selling of section 1020B products by a person who: (a) before the time of sale, has entered into a contract to buy those products; and (b) has a right to have those products vested in the person that is conditional only on all or any of the following: (i) payment of consideration; (ii) receipt of the proper instrument of transfer; or (iii) receipt of the title documents. RG 196.44 This exception allows a seller to sell the products acquired through the purchase agreement even though the seller may not have a presently exercisable and unconditional right to vest the product in the buyer because the purchase agreement to acquire the products is still conditional at the time of sale. The existence of a prior purchase agreement means that the transaction falls short of a true naked short sale. Page 14 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 14 Do these short sales need to be reported? RG 196.45 Persons relying on s1020B(4) to execute naked short sales are not required to make transactional reporting or report short positions in relation to these sales. Market makers of ETFs and managed funds RG 196.46 Section 5 of ASIC Corporations (Short Selling) Instrument 2018/745 permits market makers of certain ETFs and ASX-traded managed funds to make naked short sales of those products where all of the following apply: (a) the market maker holds an AFS licence that covers making a market in interests or securities, or is exempt from the requirement to hold such a licence; (b) the market maker has notified ASIC that it intends to rely on the relief (notice of reliance); (c) the sale occurs on a day where the operator of the fund or the foreign company allows applications for interests in the securities which are the subject of the short sale; (d) the market maker has entered into an agreement with the relevant market operator about the market maker’s obligations regarding the ETFs or managed funds, or the market maker has been appointed by the issuer of the fund to make a market in ETFs or managed funds; and (e) the short sale of interests or securities in the ETF or managed fund is made in the course of making a market in the ETF or managed fund on a licensed market. RG 196.47 The market maker is also subject to the following conditions: (a) before making an offer to sell the shorted product, the market maker must keep a record that states the proposed sale will be a short sale, and preserve the record for 12 months; (b) as soon as reasonably practicable after the short sale of ETFs and managed funds by a market maker, the market maker must acquire or apply for the issue of equivalent ETFs and managed funds to settle the short sale; (c) if the settlement failure exceeds 1% of volume or value of the sales by the market maker during a 12-month period of the naked short sales of the ETF and managed funds, the market maker must report this to ASIC within 28 days after 31 March (the end of the reporting period); (d) the market maker must notify ASIC within 28 days if it is given notice by either the market operator or the operator of the relevant ETF or managed fund of suspension or cancellation of its arrangement to make a market; and (e) the market maker must give a notice of cessation to ASIC if it no longer wishes to rely on the relief. Page 15 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 15 RG 196.48 Notifications to ASIC should be sent to: market.participants@asic.gov.au. RG 196.49 A notice of reliance should include: (a) the name and unique code of each ETF or managed fund in which the market maker will be making a market; and (b) confirmation that the market maker has either: (i) entered into an agreement with the relevant market operator; or (ii) been appointed by the issuer of the fund to make a market in those funds. RG 196.50 A new notice of reliance must be given to ASIC for any additional ETFs or managed funds in which the market maker will be making a market. RG 196.51 We recognise that market makers of ETFs and managed funds may apply for the creation of new ETFs to fulfil settlement obligations. We also note the important role of market makers who are appointed to provide liquidity to markets for ETF products and managed funds. Do these short sales need to be reported? RG 196.52 Market makers relying on this no-action position to execute naked short sales are not required to make transactional reporting of these sales. However, they are required to comply with disclosure obligations in relation to short positions that are created. Market makers: Bona fide hedging RG 196.53 A market maker (as defined in the Corporations Act) regularly states prices at which it proposes to buy or sell financial products on its own behalf. If a market maker enters a transaction with a counterparty that creates a ‘long’ exposure to an underlying product, the market maker may want to hedge the risk of this exposure by short selling the underlying product so that it has no overall exposure (i.e. a ‘delta neutral’ position) in the product. Market makers often use automated systems to immediately hedge positions established in the course of making a market. RG 196.54 Section 6 of ASIC Corporations (Short Selling) Instrument 2018/745 permits a market maker to make naked short sales where all of the following apply: (a) the market maker makes a market for a financial product; (b) the market maker holds or is exempt from holding an AFS licence for making a market; (c) the naked short sale is a bona fide transaction to hedge the risks arising from the market maker’s market-making activities; Page 16 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 16 (d) the financial product sold is either: (i) a constituent of the S&P/ASX 300 index; or (ii) an interest in STW; and (e) at the time of sale, the market maker believes on reasonable grounds that either: (i) a securities lending arrangement can be put in place before delivery of the financial product sold so that a financial product of the same class as the financial product sold can be delivered to the purchaser; or (ii) in the case of short sales of interests in STW only, the market maker can acquire or apply for interests in STW so that the interests in STW can be delivered to the purchaser. RG 196.55 This relief is subject to conditions. In order for the financial product to be unconditionally vested in the purchaser at the time of delivery, the market maker must, by the end of the sale day: (a) acquire a financial product of the same class as the financial product short sold; (b) enter into a contract to acquire a financial product of the same class as the financial product short sold; (c) have entered into a securities lending arrangement in relation to a financial product of the same class as the financial product short sold; or (d) in the case of an interest in an STW, have applied for interests in STW. RG 196.56 If the market maker has failed to do so, it must notify ASIC in writing by 9 am the following business day. Note: This relief was formerly provided by Class Order [09/774] Naked short selling relief for market makers before it was replaced by ASIC Corporations (Short Selling) Instrument 2018/745. RG 196.57 This relief does not permit naked short sales in the context of ‘pre-emptive hedging’. Pre-emptive hedging refers to the hedging of an anticipated (but not current) risk based on an expected long exposure. RG 196.58 A mere ‘expectation’ of a future long position in the absence of any market-making exposures does not satisfy the test under s1020B(5A)(b) as inserted by the ASIC Corporations (Short Selling) Instrument 2018/745. This test requires that the sale of the short product must be a bona fide transaction to manage, avoid or limit the financial consequences of the seller’s market-making activities. RG 196.59 We note that some orders undertaken in the course of market making are dependent on the fulfilment of previously agreed conditions before the Page 17 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 17 product can be issued, acquired or disposed of. In addition, the pricing of some products is determined by the hedged price. In the context of this relief, we do not consider it to be ‘pre-emptive’ hedging where the market maker has agreed to issue, acquire or dispose of a product, notwithstanding that the transaction is not yet finalised because certain agreed conditions have not yet been met. Do these short sales need to be reported? RG 196.60 Market makers relying on this relief to execute naked short sales are not required to make transactional reporting of these sales. Similarly, market makers who make covered short sales to hedge risk from their market- making activities are not required to make transaction reporting of these sales. However, sellers are required to comply with disclosure obligations in relation to short positions that are created. Exchange traded options: Sales effected by exercising options RG 196.61 Section 7 of ASIC Corporations (Short Selling) Instrument 2018/745 permits naked short selling resulting from the exercise of exchange traded options (e.g. the exercise of a put option or sale of a call option which is later exercised). This is consistent with established market practices in options markets internationally. RG 196.62 A person who buys and later elects to exercise a put option (which gives the buyer the right to sell the underlying share to another person at a specified price) would make a naked short sale if, at the time the option is exercised, the person does not have a presently exercisable and unconditional right to vest the underlying product. RG 196.63 Similarly, a person who sells a call option (which gives the buyer the right to buy the underlying share from the seller at a specified price) which is later exercised, would make a naked short sale if, at the time the option is exercised, the person does not have a presently exercisable and unconditional right to vest the underlying product. Do these short sales need to be reported? RG 196.64 Transactional reporting of covered and naked short sales resulting from the exercise of exchange traded options is not required. However, sellers are required to comply with disclosure obligations in relation to short positions that are created. Note: This relief was formerly provided under Class Order [08/764]: Short selling – exercise of exchange traded options before it was replaced by ASIC Corporations (Short Selling) Instrument 2018/745. Page 18 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 18 Exchange traded options: Sales effected by issuing options RG 196.65 Section 8 of ASIC Corporations (Short Selling) Instrument 2018/745 permits naked short selling by giving or writing certain exchange traded options. Without relief, a person could not give or write a call option without holding the underlying product or entering into a securities lending agreement. The giving and writing of options occurs in options markets internationally and significantly facilitates liquidity in the options markets. Note: This relief was formerly provided by Class Order [CO 09/1051] Short selling relief: Exchange traded options, unobtained financial products and certain bonds and debentures before it was replaced by ASIC Corporations (Short Selling) Instrument 2018/745. Do these short sales need to be reported? RG 196.66 Persons relying on this relief to execute naked short sales are not required to make transactional reporting or report short positions in relation to these sales. Exchange traded options: Unobtained financial products RG 196.67 Section 8 of ASIC Corporations (Short Selling) Instrument 2018/745 permits naked short selling of financial products where, at the time of sale, the person is able to obtain at least the number of financial products of the same class by exercising exchange traded options. We consider this practice does not involve significant settlement risk. Note: This relief was formerly provided by Class Order [CO 09/1051] Short selling relief: Exchange traded options, unobtained financial products and certain bonds and debentures before it was replaced by ASIC Corporations (Short Selling) Instrument 2018/745. Do these short sales need to be reported? RG 196.68 Persons relying on this relief to execute naked short sales are not required to make transactional reporting or report short positions in relation to these sales. Debentures: Clearing and settlement participants RG 196.69 Section 9 of ASIC Corporations (Short Selling) Instrument 2018/745 permits a person acting as principal to make naked short sales of: (a) bonds issued by a government; or (b) bonds or debentures issued by a body corporate if the amount on issue (with the same maturity and coupon terms) exceeds $100 million. However, the seller must believe on reasonable grounds that arrangements can be put in place for settlement by the relevant time. The $100 million Page 19 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 19 threshold for corporate bonds and debentures helps to ensure sufficient liquidity to reduce the likelihood of a failure to deliver. Note: This relief was formerly provided by Class Order [CO 09/1051] Short selling relief: Exchange traded options, unobtained financial products and certain bonds and debentures before it was replaced by ASIC Corporations (Short Selling) Instrument 2018/745. Do these short sales need to be reported? RG 196.70 Persons relying on this relief to execute naked short sales are not required to make transactional reporting or report short positions in relation to these sales. Deferred purchase agreements RG 196.71 Under a deferred purchase agreement (DPA), an investor agrees to purchase from the DPA issuer nominated ‘delivery products’. These are typically listed securities or managed investment products. The investor pays the purchase price to acquire the delivery products at the time they enter the DPA. However, the delivery products are not delivered until a later date (maturity), which is at least 12 months after the date the investor entered into the DPA. RG 196.72 At maturity, to meet its obligations under the DPA, the issuer acquires sufficient delivery products to deliver to the investor. After maturity, and until the investor accepts delivery of and sells the delivery products, the investor has a long exposure to the delivery products. RG 196.73 Under a DPA, the DPA issuer is taken to sell delivery products at the time the investor enters into the agreement (because of s1020B(7)) even though the quantity of products to be delivered will not be determined until maturity of the DPA (at least 12 months later). RG 196.74 Section 10 of ASIC Corporations (Short Selling) Instrument 2018/745 permits naked short selling of an ASX-listed security or managed investment product (delivery product) as a result of entering into a DPA only in circumstances designed to reduce the risk of delivery failure or any market impact that would damage market confidence or integrity in a way that is inconsistent with the policy behind the naked short selling prohibition. RG 196.75 In this regard, the relief only applies where the issuer has the ability to substitute the delivery product with another in specified circumstances (thereby addressing the risk of the delivery failure). In addition, relief is limited so that it would not apply where the reference asset (which determines the number and value of the delivery products to be delivered) is the same as the delivery product, or where the reference asset is a derivative that relates to the delivery product. Page 20 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 20 RG 196.76 The relief does not apply to an issuer who makes a naked short sale to hedge their exposure to a reference asset of a DPA. Note: This relief was formerly provided in Class Order [CO 10/111] Short selling: Limited relief for deferred purchase agreement issuers from s1020B(2) before it was replaced by ASIC Corporations (Short Selling) Instrument 2018/745. Do these short sales need to be reported? RG 196.77 Persons relying on this relief to execute naked short sales are not required to make transactional reporting or report short positions in relation to these sales. Deferred settlement trading arrangements on licensed markets RG 196.78 Part 3 of ASIC Corporations (Short Selling) Instrument 2018/745 permits naked short sales of section 1020B products on a licensed market during deferred settlement trading periods which follow a public offer or other types of corporate actions. It applies to persons who have an entitlement under the relevant corporate action to the section 1020B products, and to persons who have entered into a contract to buy the section 1020B products during the deferred settlement trading period and before the time of the short sale. RG 196.79 Various corporate actions can result in the trading of products (including securities) on a ‘deferred settlement’ basis. This means that the obligation to settle any trades in the products is deferred until a time set by the operator of the listing market. This is generally three business days after the issue date of the products. RG 196.80 In some circumstances, the sale of section 1020B products during a deferred settlement period may arguably be a technical breach of the naked short selling prohibition. RG 196.81 The relief is for an initial three-year period and will expire at the end of 30 September 2021. Conditional and deferred settlement trading following an IPO RG 196.82 Public offers often have a period of deferred settlement trading. Under ASX Operating Rule 3330, the ASX may also impose conditions on post-IPO deferred settlement trading. These conditions generally correspond with the conditions that the listing body has imposed on the IPO itself. RG 196.83 Deferred settlement trading that follows a public offer may arguably contravene the naked short selling prohibition in s1020B(2). For instance, in the case of a public offer that results in the issue of securities, the actual issuance of the securities may not have taken place at the time of the sale. Any rights that such a buyer has in the product cannot be ‘presently exercisable’ in circumstances where the product has not yet been issued. Page 21 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 21 Conditional and deferred settlement trading also contravenes s1020B(2) because the conditions on trading exceed those permitted by s1020B(4). RG 196.84 We have granted some relief for deferred settlement trading (including conditional trading) that follows a public offer because: (a) unconditional deferred settlement trading has no greater settlement risk than if the products were trading on a normal settlement basis; and (b) conditional and deferred settlement trading involves minimal settlement risk because if the conditions are not fulfilled, trades that occurred in the conditional market will be cancelled (see ASX Operating Rules 3334). RG 196.85 Section 1020B(7B) provides that a person must only sell s1020B products on a licensed market during a deferred settlement trading period if the person has an entitlement to be issued or sold the products under a public offer where the products will be quoted on ASX. RG 196.86 Section 1020B(7C) then sets out the type of entitlement required by s1020B(7B) where the public offer involves an offer of new s1020B products for issue. It provides that the person will have the requisite entitlement where, before the commencement of deferred settlement trading, the person made an application, including payment of application moneys under the offer document and the products are to be issued to applicants under the offer document subject only to all or any of the following: (a) completion of any underwriting agreement or similar as disclosed in the offer document; (b) completion of any corporate restructure or corporate transaction as disclosed in the offer document; (c) the decision by the listing entity to issue products to applicants under the offer document. RG 196.87 Section 1020B(7D) sets out the type of entitlement required by s1020B(7B) where the public offer involves an offer of existing s1020B products for sale. It contains similar terms to s1020B(7C) but tailored to a transfer rather than issue of s1020B products. RG 196.88 Due to the definition of ‘deferred settlement trading arrangements’ in s1020B(7F), the provisions in s1020B(7A)–(7F) apply to both deferred settlement trading following a public offer and the less common circumstances where a conditional market has been declared in accordance with ASX operating rules. RG 196.89 If the trading conditions do not come within the standard conditions contained in s1020B(7C)(b) or s1020B(7D)(b), the entity will need to apply for individual relief. The application should explain the reason for the non- standard condition and why it will be imposed. Page 22 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 22 Deferred settlement trading of unissued products following various corporate actions RG 196.90 In the case of some corporate actions, section 1020B products may commence trading on a licensed market before they are issued. Trading will then occur on a deferred settlement basis. RG 196.91 ‘Corporate action’ means a proposed issue of section 1020B products under or in connection with: (a) a compromise or arrangement under Pt 5.1 of the Corporations Act; (b) a rights issue; (c) a dividend or distribution reinvestment plan; (d) a bonus issue; (e) a conversion of convertible notes or convertible securities; or (f) a conversion of shares under s254H of the Corporations Act. RG 196.92 Arguably, a person who sells unissued section 1020B products during a deferred settlement trading period cannot have a presently exercisable and unconditional right to vest the products in a buyer. This is because any rights that such a buyer has in the product cannot be ‘presently exercisable’ in circumstances where the product has not yet been issued. It follows that a person who sells unissued products in these circumstances may be in technical breach of the naked short selling prohibition. This may also be the case where a purchaser of the unissued section 1020B products makes a further sale of the products. RG 196.93 Section 11 of ASIC Corporations (Short Selling) Instrument 2018/745 inserts s1020B(7G)–(7J) into the Corporations Act. Section 1020B(7H) permits the naked short sale of unissued section 1020B products on a licensed market during a deferred settlement trading period by a person who has an entitlement to be issued with the section 1020B products under or in connection with a ‘corporate action’: see RG 196.86. RG 196.94 This exception also extends to a person who has entered into a contract to buy the unissued section 1020B products during the deferred settlement period and before the time of the short sale. RG 196.95 We consider that, during these deferred settlement trading periods, the risk of settlement failure is no greater than would be the case if the section 1020B products had been issued and were trading on a normal settlement basis (i.e. two business days after the trade date, or T+2). Page 23 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 23 Do these short sales need to be reported? RG 196.96 Persons relying on the relief in Part 3 to execute naked short sales are not required to make transactional reporting or report short positions in relation to these sales. IPOs: Sale offers through special purpose vehicles RG 196.97 Section 12 of ASIC Corporations (Short Selling) Instrument 2018/745 provides relief from s1020B for certain naked short sales by a special purpose vehicle (saleco) during an IPO. RG 196.98 IPOs may involve shareholders of a company seeking listing (listing company) selling some or all of their shares. Usually the shareholders’ sale offer is conducted through a special purpose vehicle or saleco. The shareholders agree to transfer their shares to the saleco, or an IPO applicant nominated by the saleco, for the purposes of the IPO. In turn, the saleco will invite applications for the sale of the shares in a prospectus, which the saleco and the listing company will lodge with ASIC under s718 of the Corporations Act. RG 196.99 The shareholders’ agreement to transfer their shares to the saleco (or an applicant nominated by the saleco) will typically be conditional on ASX granting approval for the admission of the listing company. This condition ensures the shareholders do not have to transfer their shares if the IPO does not proceed. Note: If ASX does not grant approval and quotation of the listing company’s shares, then s723(3) of the Corporations Act operates to prevent the saleco from transferring the shares to applicants and the listing company from issuing shares. RG 196.100 Depending on the terms of the arrangements, it is arguable that the saleco’s offer of shares in the prospectus contravenes s1020B(2) because: (a) the saleco will not have a presently exercisable and unconditional right to vest the shares in IPO applicants if the saleco’s right to obtain the shares from the existing shareholders is conditional on ASX listing— which is not a condition permitted by s1020B(4); and (b) the saleco may not be selling on behalf of the existing shareholders, particularly given that it is the saleco that makes the offer under the prospectus to IPO applicants. RG 196.101 Section 12 of ASIC Corporations (Short Selling) Instrument 2018/745 provides relief from s1020B for standard IPO sell-downs where: (a) the sale shares are in a company seeking listing on ASX; (b) the sale offer is being made under a prospectus or pathfinder in connection with the proposed listing on ASX; Page 24 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 24 (c) at the time of the offer under the prospectus, there is an agreement between the saleco and the selling shareholder (who must have a presently exercisable and unconditional right to vest shares in a buyer) for transfer of the shares to the saleco (or a nominee); and (d) the selling shareholder’s agreement to sell the shares to the saleco is conditional on ASX listing. RG 196.102 It is also a condition of the relief that the listing company makes an offer of shares in the same class as the sale shares under the prospectus or pathfinder prospectus. This condition ensures that the listing company has statutory responsibility for disclosure in the prospectus or pathfinder. Note: We will oppose any IPO seeking listing on a financial market that does not involve an offer of securities by the listing company, whether or not there is an IPO sell-down. RG 196.103 We will continue to consider case-by-case relief for more unusual IPO sell-downs, including where the shares have not yet been issued to the selling shareholders due to a group restructure that is conditional on the IPO. Do these short sales need to be reported? RG 196.104 Persons relying on this relief for IPO sell-downs are not required to make transactional reporting or report short positions in relation to these sales. Selling before completing a recall of loaned securities RG 196.105 In ASIC Advisory (AD08-23) No action position for owners selling from stock lending (24 September 2008), we announced a no-action position permitting naked short sales by the owner (seller) of a portfolio of securities placed in an established securities lending program where: (a) the sale is a bona fide sale transaction from the portfolio; (b) the seller has made securities of the same type available (whether or not through a custodian) to the securities lender for use in a securities lending program, being securities in which the seller had full beneficial ownership or which they held as an institutional investor (e.g. in a managed investment scheme, superannuation fund or insurance company statutory fund); (c) at the time of sale, the seller is entitled to recall from the program at least the number of securities which are the subject of the sale; (d) before, or as soon as practicable after, the sale the seller recalls in writing or electronically a sufficient number of securities from the program to settle the sale; and (e) the sale is settled at the time required by the market rules (i.e. T+2). Note: For the purposes of this no-action position, a security includes a managed investment product. Page 25 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 25 RG 196.106 Under a typical securities lending agreement, the lender has the right to recall securities loaned under the agreement. Ordinarily, an owner who wishes to sell the securities placed in a securities lending program first must wait until those securities are delivered back to the owner. Do these short sales need to be reported? RG 196.107 Persons relying on this no-action position to execute naked short sales are not required to make transactional reporting or report short positions in relation to these sales. Selling CDIs before conversion RG 196.108 We will consider issuing individual no-action positions permitting naked short selling of certain CDIs by a person who has a presently exercisable and unconditional right to vest equivalent underlying securities in a buyer where: (a) as soon as practicable after the sale, the person takes all necessary steps to convert equivalent securities into CDIs of the class sold; (b) the person uses their best endeavours to ensure that delivery of CDIs of the class sold is made to the buyer on the date delivery is due; and (c) the person or their broker reports the short sale to ASX. RG 196.109 We consider these sales are analogous to a long sale and do not present significant settlement risks, given the seller would have a presently exercisable and unconditional right to vest the underlying security at the time of sale. This exception would also provide additional liquidity to the market for CDIs. Do these short sales need to be reported? RG 196.110 Persons relying on this no-action position to execute naked short sales are required to make transactional reporting of these sales to ASX. Client facilitation services RG 196.111 We will consider issuing individual no-action positions permitting brokers to make naked short sales of securities in the course of certain types of client facilitation services. For instance, a broker may make a short sale of securities to a client in response to a client’s buy order. Naked short sales are permitted subject to the following conditions: (a) the broker has an existing business of providing facilitation services; (b) the short sale to the client is a bona fide facilitation transaction in the ordinary course of the broker’s facilitation business; and (c) the broker makes reasonable inquiries of its facilitation client to understand the purpose of the client’s trading. Page 26 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 26 RG 196.112 Following recent consultation on this topic, we added further conditions to this relief requiring that: (a) at the time of the sale, the broker believes on reasonable grounds that a securities lending arrangement can be put in place so that the shorted product can be unconditionally vested in the buyer by the time for delivery; and (b) by the end of the day on which the broker makes the sale of the security, the broker: (i) acquires an equivalent security; or (ii) enters into a contract to acquire an equivalent security; or (iii) enters into a securities lending arrangement in relation to an equivalent security, so that the security can be unconditionally vested in the buyer at the time of delivery. Note: For more information, see Report 167 Response to submissions on CP 106 Short selling to hedge risk from market making activities (REP 167). RG 196.113 We consider that client facilitation services add to the efficient operation of the financial markets and are analogous to market-making services, for which naked short selling is permitted to hedge risk: see RG 196.53–RG 196.60. Do these short sales need to be reported? RG 196.114 Persons relying on this no-action position to execute naked short sales are not required to make transactional reporting of these sales. However, they are required to comply with disclosure obligations in relation to short positions that are created. Page 27 REGULATORY GUIDE 196: Short selling © Australian Securities and Investments Commission October 2018 Page 27 D Short selling disclosure Key points A person who short sells on a licensed market will need to ensure that they comply with the short selling disclosure requirements. There are two types of disclosure requirements: short sale transaction (gross) reporting (see RG 196.121–RG 196.148) and short position reporting (see RG 196.149– RG 196.193). A person who makes a covered short sale through a broker (AFS licensee) must repo