Regulatory authorities consider imposing more stringent pre-borrowing requirements, additional reporting obligations and greater public transparency regarding short sales in response to international trends and prior feedback.
What you need to know
- On December 8, 2022, the Canadian Securities Administrators (the CSA) issued CSA Staff Notice 25-306 Activist Short Selling Update summarizing comments to CSA Consultation Paper 25-403 Activist Short Selling published in December 2020.
- Concurrently, the CSA and the Investment Industry Regulatory Organization of Canada (IIROC) – now the New Self-Regulatory Organization of Canada (the New SRO), a consolidation of IIROC and the Mutual Fund Dealers Association of Canada – published Joint CSA and IIROC Staff Notice 23-329 Short Selling in Canada requesting additional public comments on short selling regulatory considerations.
- Market participants and other stakeholders may take part in the consultation process until March 8, 2023. We would be pleased to answer your questions and assist you in preparing submissions.
What is short selling?
- A “short sale” involves selling a security (other than a derivative instrument), which the seller does not own, at the current market price either expecting to cover the short position by purchasing later at a lower price, or to profit from the difference in price between the security sold short and another security. A “failed trade” occurs when a seller fails to deliver the security, or the buyer fails to pay the funds, on the settlement date.
- Short selling is a common trading practice and can contribute to market liquidity, promote price discovery and help market participants manage certain risks. However, short selling can carry risks and be vulnerable to manipulative and deceptive trading activities. Short sales are therefore subject to a well-developed regulatory framework and monitoring by the New SRO for potentially abusive trading activity.
Current regulatory regime
A person placing an order for the sale of a security with a registered dealer must declare to the dealer at the time of placing the order if they do not own the security. Further, IIROC’s Universal Market Integrity Rules (UMIR) require market participants to have a reasonable expectation, at the time of entering a short sale order, to settle a resulting trade on the settlement date, which IIROC has reiterated in a recent Guidance Note.
Select dealers and subscribers or users of a marketplace are subject to various obligations under UMIR, including but not limited to:
- a requirement to designate all orders representing short sales as either “short” or “short-marking exempt” to ensure orders bear the correct identifier;
- a requirement to report “extended failed trades” to IIROC; and
- the ability for IIROC to designate a security as a “pre-borrow security” or “short-sale ineligible security”.
Nonetheless, unlike other jurisdictions, Canadian securities laws and regulations do not impose requirements to report or disclose information on short positions of individual accounts. Since the repeal of the “tick test” from UMIR in 2012, there are also no restrictions on the minimum price at which short sales may occur in Canada.
Request for comments
Market participants and other stakeholders have until March 8, 2023 to submit comments on Canada’s regime governing short sales and the following regulatory considerations:
- the repealed tick test and its impact on capital markets;
- the current regime under which pre-borrowing is required in certain circumstances in contrast to the American requirements;
- the UMIR definition of “failed trade” and the ten-trading day threshold;
- greater public transparency in respect of short selling activities and short positions;
- additional reporting, transparency or other requirements on junior issuers in light of IIROC’s failed trade study; and
- mandatory close-out or buy-in requirements similar to those in the United States and the European Union, as recommended by the Ontario Capital Markets Modernization Taskforce.
Please contact your BLG lawyer for assistance in understanding the impact of the short selling regulatory framework on your business or in preparing submissions. You may also contact the authors of this article or any of the key contacts noted below.