Brussels,

Short Selling​

​Short selling involves selling a security that the seller does not own at the time of the agreement, intending to buy it back later to deliver it. There are two types of short selling:
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  • Covered Short Selling: The seller borrows the securities before making the sale.
  • Naked Short Selling: The seller has not borrowed the securities at the time of the sale.

A Credit Default Swap (CDS) is a derivative contract that acts as insurance against the risk of credit default on a corporate or government bond. The seller of a CDS pays the buyer the face value of the bond if the issuer defaults. An uncovered or naked CDS is when the buyer is not exposed to the credit risk of the underlying reference entity.

Risks of Short Selling and CDS

Short selling and CDS can provide economic benefits, such as increased market liquidity. However, they also carry risks:
  • Negative Price Spirals: Rapid price declines due to mass short selling.
  • Settlement Failures: Inability to deliver securities as promised.
  • Transparency Deficiencies: Lack of visibility can threaten financial stability, market integrity, and create information asymmetries.

EU Regulations

Following the 2008 financial crisis, many EU countries suspended or banned short selling, but uncoordinated measures allowed circumvention and created costs for investors. In response, the EU adopted a regulation in 2012 to:
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  1. Increase Transparency: Requires the flagging of short sales for regulatory awareness.
  2. Empower National Regulators: Allows temporary restrictions or bans on short selling under exceptional circumstances, coordinated by the European Securities and Markets Authority (ESMA).
  3. Ensure Adequate Clearing Arrangements: Mandates central counterparties to have buy-in arrangements and fines for settlement failures.