The International Organization of Securities Commissions’ Technical Committee has published a consultation paper setting out proposed principles for the regulation of short selling, IOSCO said Monday.

The report recommends that effective regulation of short selling should be based on four main principles:

> short selling activities should be subject to controls designed to minimize the potential risks that could affect the orderly and efficient functioning and stability of financial markets;

> short selling should be subject to a reporting regime that provides timely information to the market or to market authorities;

> short selling should be subject an effective compliance and enforcement system; and

> short selling regulations should allow exceptions for certain types of transactions for efficient market functioning and development.

The report also outlines the minimum that regulators should do in order to support each of the four principles.

The paper was drafted by a task force established by the Technical Committee in November 2008 in response to concerns regarding the impact short selling was having in the extreme market conditions created by the financial crisis. Its goal were to work to eliminate gaps between the different regulatory approaches to naked short selling whilst minimizing any adverse impact on legitimate activities, such as securities lending and hedging, which are critical to capital formation and reducing market volatility.

Martin Wheatley, CEO of the Securities and Futures Commission of Hong Kong and chairman of the Task Force on Short Selling, said, “We believe that short selling should operate in a well structured regulatory framework in the interests of maintaining a fair, orderly and efficient market. The objective of such regulation being to reduce the potential destabilizing effect that short selling can cause without exerting undue impact on its legitimate benefits in capital formation and volatility reduction.”

“While IOSCO encourages a concerted move towards a consistent approach to short selling, it recognizes that the case for the regulation of this activity varies from jurisdiction to jurisdiction and depends on a range of domestic factors. These principles will provide guidance to market authorities and assist them in assessing and developing their short selling regulatory framework,” Wheatley added.

“IOSCO believes that short selling plays an important role in capital markets for a variety of reasons including more efficient price discovery, mitigating price bubbles, increasing market liquidity, facilitating hedging and other risk management activities. However there is also a general concern that, especially in extreme market conditions such as we have recently experienced, certain types of short selling or the use of short selling in combination with certain abusive strategies may contribute to disorderly markets,” said Kathleen Casey, chairman of the Technical Committee, and an SEC commissioner.

“These principles have been developed with a view to striking a balance between realizing the potential benefits of short selling and reducing the adverse impact on financial markets that may arise from abusive short selling,” she added.

The deadline for responses to the consultation paper is May 4.

IE