Explanatory Memorandum
Circulated by the authority of the Minister for Superannuation and Corporate Law, Senator the Hon Nick SherryChapter 3 Schedule 2 - Amendments commencing on the 28th day after Royal Assent
Outline of chapter
3.1 Schedule 2 of the Bill contains amendments to prohibit certain short sale transactions.
Context of amendments
3.2 The Corporations Act, at subsection 1020B(2), provides that a person can only sell certain financial products if the person has, or believes on reasonable grounds that they have, a presently exercisable and unconditional right to vest the products in the buyer. If the person is selling the products on behalf of another person (for example, a broker selling on behalf of a client), the other person (the client) must have, or believe on reasonable grounds that they have, a presently exercisable and unconditional right to vest the products in the buyer.
3.3 The Act, however, allows certain exceptions to this rule. For the most part, the exceptions to this rule are commonly referred to as 'naked short sales'.
3.4 Various concerns have been expressed in relation to naked short selling. Transactions of this nature may have a higher risk of settlement failure (because the seller does not have a presently exercisable and unconditional right to vest the products at the time of sale). They may also distort the operation of financial markets by causing increased price volatility and potentially facilitating market manipulation. In addition, the perceived activity of naked short sellers is likely to damage market confidence particularly among retail investors. For these reasons, naked short selling has the potential to damage the integrity of Australian financial markets.
3.5 In light of this, and given the limited evidence of any significant, market-wide benefits from naked short sale transactions, it was considered appropriate to remove the general ability for people to enter into these transactions under the Corporations Act.
Summary of new law
3.6 The amendments prohibit naked short selling.
3.7 Under section 1020F of the Corporations Act, ASIC has the ability to grant exemptions from this prohibition.
Comparison of key features of new law and current law
| New law | Current law |
| The seller of section 1020B products must have a presently exercisable and unconditional right to vest the products in the buyer. There are no exceptions from this requirement that would allow for naked short selling. However, ASIC has the power to issue exemptions from the prohibition. | Includes some exceptions from the requirement for a seller to have a presently exercisable and unconditional right to vest the products in the buyer. In general, these exceptions allow for naked short selling of section 1020B products. |
Detailed explanation of new law
3.8 The amendment removes the exceptions from the existing requirement in subsection 1020B(2) for a person selling a section 1020B product to have, or believe on reasonable grounds they have, a presently exercisable and unconditional right to vest the products in the buyer. If the person is selling the products on behalf of another person (for example, a broker selling on behalf of a client), the other person (the client) must have, or believe on reasonable grounds they have, a presently exercisable and unconditional right to vest the products in the buyer.
3.9 In particular, Schedule 2 repeals exceptions from subsection 1020B(2) relating to:
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- odd lot transactions (existing paragraph 1020B(4)(a));
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- arbitrage transactions (existing paragraph 1020B(4)(b));
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- transactions where arrangements have been made before the time of sale that will enable delivery of the products in time for settlement (existing paragraph 1020B(4)(d)); and
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- transactions made under a declaration from the operator of a licensed market in accordance with the operating rules of the market (existing paragraph 1020B(4)(e)).
[Schedule 2, item 2]
3.10 In addition, existing subsections 1020B(5) and 1020B(6) and section 1020C relating to the operation of subsections 1020B(4)(b), 1020B(4)(d) and 1020B(4)(e) are repealed because they are no longer necessary. [Schedule 2, items 2 and 3]
3.11 Schedule 2 inserts new subsection 1020B(4) made up of the existing paragraph 1020B(4)(c). This subsection applies to circumstances where a seller has previously purchased the section 1020B products being sold, but that purchase agreement is conditional only upon a limited range of factors. This subsection 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 products in the buyer because the purchase agreement to acquire the products is still conditional at the time of sale. The existence of the prior purchase agreement means that the transaction falls short of true naked short selling. For this reason, it is not necessary to repeal this exception. [Schedule 2, item 2]
3.12 ASIC has the power under section 1020F to issue exemptions for subsection 1020B(2) that would allow naked short sales in certain circumstances.
Consequential amendments
3.13 Schedule 2 amends subsections 1020B(1), 1200F(1) and Schedule 3 of the Corporations Act to remove references to sections that are repealed by the Bill. [Schedule 2, items 1, 4 and 5]