House of Representatives

Corporations Amendment (Short Selling) Bill 2008

Explanatory Memorandum

Circulated by the authority of the Minister for Superannuation and Corporate Law, Senator the Hon Nick Sherry

Chapter 4 Schedule 3 - Amendments commencing on Proclamation

Outline of chapter

4.1 Schedule 3 amends the Corporations Act 2001 (the Corporations Act) to require the disclosure of transactions to sell section 1020B products when the seller has entered into a securities lending arrangement.

Context of amendments

4.2 The Corporations Act, at section 1020B, currently regulates short selling of securities, managed investment products and certain other financial products (section 1020B products).

4.3 Section 1020B generally prohibits the sale of a section 1020B product unless a person has a 'presently exercisable and unconditional right' to vest the product at the time of sale.

4.4 Short sellers need to make arrangements to cover their delivery obligations before they fall due. This is normally done by:

making a matching purchase at some point following the sale but before delivery falls due; or
borrowing an equivalent amount of securities before delivery falls due, either before they enter into the sale or at some time between making the sale and when required to make delivery.

4.5 A naked short sale occurs where a seller does not own or has not borrowed or arranged to borrow securities at the time of sale but intends to purchase or borrow securities in order to meet the three business day settlement obligation.

4.6 There is some discussion about what constitutes a covered short sale. The broadest approach is to focus on whether borrowing takes place to meet delivery obligations. On this approach a covered short sale occurs where the seller has arranged to borrow stock in order to meet their delivery obligations.

4.7 A borrowing arrangement (or securities lending arrangement) occurs where the seller enters into an agreement or arrangement with a lender under which the section 1020B products will be delivered to the seller, and title transferred, on the condition that the seller will return, at a future date, the original or equivalent replacement section 1020B products to the lender. Loans in Australia are often made using a standard form of contract, the Australian Master Securities Lending Agreement.

4.8 While a borrowing agreement is economically a loan, there is a legal transfer of title between the lender and borrower, which allows the borrower to vest title to the section 1020B products in another person.

4.9 There is uncertainty around the use of stock lending agreements, the application of subsection 1020B(2), and therefore the requirement to disclose to a financial services licensee, in certain circumstances, that the transaction is a short sale (subsection 1020B(5)). It is understood that most market participants consider that a covered short sale falls within subsection 1020B(2) and so need not be disclosed.

4.10 Market practice has developed so that covered short sales are not usually reported to the market on the argument that they are not truly 'short' because the seller, relying on the borrowed stock, has a 'presently exercisable and unconditional right to vest the product' at the time of sale. Some limited reporting does occur.

4.11 While a person may borrow stock any time after the sale in order to meet delivery, subsection 1020B(2) requires that a person has a 'presently exercisable and unconditional right to vest the product' at the time of sale. If this is not the case, section 1020B applies to the sale.

4.12 ASIC Regulatory Guide 196 sets out the circumstances in which a seller has a 'presently exercisable and unconditional right to vest the product' in relation to a borrowing agreement.

4.13 The amendments will ensure that covered short sales are disclosed.

Summary of new law

4.14 The amendments require sellers of section 1020B products to advise their executing AFS Licensee when the sale is a covered short sale (a short sale supported by a securities lending arrangement). In turn, the AFS Licensee must report the disclosed covered short sales to the relevant market operator. AFS Licensees must also report principal covered short sales to the relevant market operator.

4.15 The market operator must publicly disclose reported short sale information.

4.16 The disclosure regime applies to sales made on a licensed market (such as the ASX) and sales that occur through on or off market crossings.

4.17 The disclosure requirement applies whether the seller is inside or outside Australia.

4.18 It is an offence if sellers and AFS Licensees do not provide particulars of the sale of section 1020B products, at the time and in the manner required by the regulations. Regulations will set the mechanics of disclosure from sellers to AFS Licensees and AFS Licensees to the market operator, including when and how disclosure occurs. Regulations will also set the manner and time of public disclosure by the market operator, which will include the disclosure of aggregate short sale information.

4.19 To complement the disclosure regime, AFS Licensees must also ask whether the sale is a covered short sale before making the sale. This should assist in ensuring that clients, particularly overseas clients, understand their obligations to report those short sales. It is an offence if AFS Licensees do not make these inquiries.

Comparison of key features of new law and current law

New law Current law
Disclosure of short sales covered by securities lending agreements
Sellers of section 1020B products must advise their executing Australian Financial Services (AFS) Licensee when the sale is a covered short sale. The AFS Licensee must report the disclosed client short sales to the relevant market operator, while also reporting the AFS Licensee own principal covered short sales.
The time and manner of disclosure will be contained in the regulations.
Covered short sales are not usually reported to the market on the argument they are not truly 'short' because the seller, relying on the borrowed stock, has a 'presently exercisable and unconditional right to vest the product' at the time of sale. Some limited reporting does occur.
AFS Licensee inquiry obligation
The AFS Licensee must not make a sale of a section 1020B product unless the AFS Licensee has asked the seller whether they are required to disclose that the sale is a covered short sale. AFS Licensees must also record the seller's answer. There is no current AFS Licensee inquiry obligation in the Corporations Act. On 19 September 2008, ASIC used its modification power under section 1020F of the Corporations Act to impose a similar AFS Licensee inquiry obligation. This inquiry obligation is designed to operate until these amendments commence.
The ASX market rules include a similar inquiry obligation on ASX participants but this does not, in practice, apply to covered short selling as the market generally perceives that the ASX rules do not apply to covered short selling.
New law Current law
Public disclosure by market operator of short sale information
The market operator (for example the ASX) must publicly disclose the short sale information it receives in the manner and time contained in the regulations. The ASX currently discloses aggregate short sale information it receives under section 1020B but there is no express legal requirement for it to do so.

Detailed explanation of new law

4.20 Schedule 3 inserts Division 5B of Part 7.9 of the Corporations Act to require disclosure of short sales of section 1020B products covered by a securities lending arrangement. [Schedule 3, item 3]

Key definitions for Division 5B

4.21 crossing: an AFS Licensee makes a sale of section 1020B products either on behalf of the buyer and seller of the products, or on behalf of a client on one side of the trade and as principal on the other side. [Schedule 3, item 3, subsection 1020AA(1)]

4.22 sale: the entering into an agreement to sell section 1020B products is treated as the sale of the products. [Schedule 3, item 3, subsection 1020AA(2)]

4.23 section 1020B products: securities, managed investment products, a debenture, stock or bond issued or proposed to be issued by a government or financial products prescribed by regulation (existing subsection 1020B(1)). Regulation 7.9.80B prescribes certain financial products for the purposes of subsection 1020B(1). [Schedule 3, item 3, subsection 1020AA(1)] .

4.24 securities lending arrangement: the lender agrees to deliver particular financial products to the borrower, and vest title, on the condition that the borrower will return, at a future date, the original or equivalent replacement financial products to the lender, and vest title. The definition of securities lending arrangement also encompasses the possibility that the lender will deliver, and vest title in, the particular financial products to a third party on the instruction of the borrower, and in return, the borrower may return the financial products to a third party nominated by the lender. [Schedule 3, item 3, subsection 1020AA(1)]

Client and principal disclosure

4.25 The amendment governs client and principal disclosure of short sales of section 1020B products covered by a securities lending arrangement. [Schedule 3, item 3, subsection 1020AB(1)]

4.26 The disclosure requirement applies:

where an AFS Licensee makes a sale of section 1020B products on a licensed market, on its own behalf, or on behalf of a person, to a buyer; [Schedule 3, item 3, paragraph 1020AB(1)(a)]
before the time of sale, the seller entered into, or gained the benefit of, a securities lending arrangement; [Schedule 3, item 3, paragraph 1020AB(1)(b)]
at the time of sale, the seller intends that the securities lending arrangement will ensure that some or all of the section 1020B products can be vested in the buyer. [Schedule 3, item 3, paragraph 1020AB(1)(c)]

4.27 The disclosure requirement applies to both client and principal trading in section 1020B products on a licensed market. A crossing of a section 1020B product is treated as being made on a licensed market. On the ASX, a crossing is conducted by an ASX participant but may occur on or off-market. Crossings are treated as being made on a licensed market, whether the crossing occurs on or off-market. [Schedule 3, item 3, subsection 1020AA(4)]

4.28 The definition of securities lending agreement covers the circumstances where a seller has entered a securities lending arrangement, or received the benefit of such an arrangement, before the time of sale. Such a benefit could arise if the borrower directed the lender to vest the section 1020B products in a third party, who subsequently short sells. [Schedule 3, item 3, subsection 1020AA(1) and paragraph 1020AB(1)(b)]

4.29 For the avoidance of doubt, the amendments clarify that a sale in economic substance is treated as if the sale is made by an AFS Licensee on behalf of a person. An example includes that a sale request is passed from the person to the AFS Licensee through a chain of intermediaries. [Schedule 3, item 3, subsection 1020AA(3)]

Mechanics of disclosure

4.30 It is an offence if client and principal sellers (AFS Licensees) do not provide particulars of the sale of 1020B products, at the time and in the manner required by the regulations. The particulars include when disclosure occurs and the manner of such disclosure. [Schedule 3, item 3, subsection 1020AB(3)]

4.31 This will facilitate disclosure from client sellers to AFS Licensees, and AFS Licensees (as principal sellers) to the market operator. [Schedule 3, item 3, subsection 1020AB(4)]

4.32 Details about the mechanics of disclosure are to be included in the regulations so that the regime is able to adapt more readily to the rapid and ever evolving changes in markets, and the mechanisms by which transactions occur. The matters to be contained in the regulations will specify the technical requirements of disclosure.

4.33 The penalty for the offence is the same as the penalty that was in place under the former short selling disclosure regime under repealed subsection 1020B(5). [Schedule 2, item 2] The penalty is 25 penalty units or imprisonment for six months, or both. [Schedule 3, item 6]

4.34 The requirement to provide particulars of the sale of section 1020B products, at the time and in the manner required by the regulations, applies whether the seller is inside or outside Australia. [Schedule 3, item 3, subsection 1020AB(2)]

4.35 The ability of the regulations to allow things to be specified differently for different kinds of persons, things or circumstances may be relevant in this context. For example it may not be possible for all kinds of sellers to comply with the same mechanics of disclosure under the regulations. [Schedule 3, item 3, section 1020AF]

AFS Licensee disclosure

4.36 AFS Licensee must disclose short sales covered by a securities lending arrangement where an AFS Licensee receives information from a client on the particulars of the sale of section 1020B products on a licensed market. [Schedule 3, item 3, paragraph 1020AC(1)(a)]

Mechanics of disclosure

4.37 It is an offence if AFS Licensees do not provide particulars of disclosed client sales of section 1020B products, at the time and in the manner required by the regulations. The particulars include when the disclosure occurs and the manner of such disclosure. [Schedule 3, item 3, subsection 1020AC(2)]

4.38 This will facilitate disclosure from AFS Licensees to the relevant market operator. [Schedule 3, item 3, subsection 1020AC(3)]

4.39 The penalty for the offence is the same as the penalty for non disclosure by the seller under section 1020AB. The penalty is 25 penalty units or imprisonment for six months, or both [Schedule 3, item 6] .

Public disclosure of information

4.40 The relevant market operator must make a public disclosure of the sale of section 1020B products on a licensed market where they receive information from:

the AFS Licensee who provides proprietary short sale information to the market operator in accordance with section 1020AB. [Schedule 3, item 3, subparagraph 1020AD(1)(a)(i)]
the AFS Licensee who provides client short sale information to the market operator in accordance with section 1020AC. [Schedule 3, item 3, subparagraph 1020AD(1)(a)(ii)]
Directly from the seller (client) mentioned in subparagraph 1020AB(1)(a)(i). This relates to where regulations specify that the client seller discloses to another entity other than the AFS Licensee under subparagraph 1020AB(4)(a)(ii) (see further regulation making power) [Schedule 3, item 3, subparagraph 1020AD(1)(a)(iii)]

Mechanics of disclosure

4.41 It is an offence if the relevant market operator does not provide particulars of disclosed client and proprietary sales of section 1020B products, at the time and in the manner required by the regulations. The particulars include when the disclosure occurs and the manner of such disclosure. [Schedule 3, item 3, subsection 1020AD(2)]

4.42 This will facilitate the public disclosure of aggregate and reportable short sale information.

4.43 The penalty for the offence is the same as the penalty for non disclosure by the seller under section 1020AB. The penalty is 25 penalty units or imprisonment for six months, or both. [Schedule 3, item 6]

Licensee's obligation to ask seller about short sale

4.44 Where an AFS Licensee is to make a sale of section 1020B product, on behalf of a person (client), and the AFS Licensee is responsible under section 1020AB for receiving short sale information from client sellers, the AFS Licensee must, before the sale:

ask the seller, orally or in writing, whether the seller is required under section 1020AB to give them information in relation to the sale; and
record the seller's answer in writing [Schedule 3, item 3, section 1020AE] .

4.45 Under section 25 of the Acts Interpretation Act 1901 , writing includes any mode of representing or reproducing words, figures, drawings or symbols in a visible form.

4.46 It is an offence if the licensee does not comply with section 1020AE. The penalty for the offence is the same as the penalty for non disclosure by the seller under section 1020AB. The penalty is 25 penalty units or imprisonment for six months, or both. [Schedule 3, item 6]

Other regulation making powers

4.47 New Division 5B of Part 7.9 permits other regulations to be made, which could amend the operation of the disclosure requirement to:

require the client (seller) to disclose to an entity other than the AFS Licensee; [Schedule 3, item 3, subparagraph 1020AB(4)(a)(ii)]
require the AFS Licensee to disclose short sale information (from proprietary or client trading) to an entity other than the market operator. [Schedule 3, item 3, subparagraph 1020AB(4)(b)(ii) and paragraph 1020AC(3)(b)] That entity will also be responsible for public disclosure; [Schedule 3, item 3, section 1020AD]
specify the kind of section 1020B products the disclosure regime applies to; [Schedule 3, item 3, subparagraphs 1020AB(1)(d)(i)(ii), 1020AC(1)(b)(i)(ii)) and 1020AD(1)(b)(i)(ii)]
specify circumstances in which the sale is made; and [Schedule 3, item 3, subparagraphs 1020AB(1)(d)(iii), 1020AC(1)(b)(iii)) and 1020AD(1)(b)(iii)]
allow matters or things to be specified differently for different kinds of persons, things or circumstances. [Schedule 3, item 3, section 1020AF]

4.48 This does allow, in future, an alternative approach to disclosure, which could change the vehicle for disclosure (for example, requiring sellers to disclose direct to a regulator) and target disclosure of covered short sales to particular circumstances. This flexibility is included:

to allow the law to respond to an environment of rapid change, including technological innovation and ongoing developments in the conduct and structures of financial markets; and
because the new disclosure requirement will facilitate greater understanding of this area and may reveal a case for change to target the disclosure requirement to better serve the objectives of disclosure. One example could include targeting of reporting requirements to particular kinds of section 1020B products, such as securities of a particular sector.

Consequential amendments

4.49 The amendment reflects that new Division 5B applies in relation to securities and debentures, stocks and bonds issued by government. [Schedule 3, items 1 and 2]

4.50 The amendment reflects that the definition of section 1020B products is applicable also to Division 5B. [Schedule 3, item 4]

4.51 The amendment reflects that the new short selling disclosure provisions are not excluded from recognised offers under Chapter 8 of the Corporations Act. Section 1200F(1) of the Act lists provisions that do not apply to recognised offers with New Zealand. Short selling provisions, however, do apply. [Schedule 3, item 5, subsection 1200F(1)]


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