18 January 2023
by Canadian Securities Regulatory Monitor (Toronto) , Sean Sadler (Toronto), Rene Sorell (Toronto), Jacob A. Robinson (Toronto) and Cristian Blidariu (Toronto)
McCarthy Tétrault LLP
Last month, the Canadian Securities Administrators (CSA) and Investment Industry Regulatory Organization of Canada (now temporarily named the New Self-Regulatory Organization of Canada but in this note referred to as IIROC) issued Joint Staff Notice 23-329 Short Selling in Canada (the Staff Notice) to provide an overview of the existing regulatory landscape surrounding short selling, give an update on current related initiatives and request public feedback on a few specific topics.
Accompanying this announcement, the CSA also published a summary of comments and responses to CSA Consultation Paper 25-403 Activist Short Selling, a paper drafted to facilitate the discussion of concerns relating to the impact of activist short selling on capital markets. The summary of these comments can be found here.
How Staff Notice defines short sales and failed trades
The Staff Notice defines a “short sale” as a sale of a security, other than a derivative instrument, which the seller does not own either directly or through an agent or trustee. A “failed trade” occurs “when a seller (whether short or long) fails to deliver securities or the buyer fails to pay the funds when delivery/payment is due, currently on the second business day after the trade date, unless a later settlement date is agreed to by all parties at the time of the trade”.
Existing Canadian Short Sale Framework
Canadian securities legislation and IIROC provide the following framework for short selling.
Canadian securities legislation
- Canadian securities legislation requires a person who places a short sale order with a registered dealer has to declare to the dealer at the time of placing the order that the seller does not own the security.
- Securities legislation including National Instrument 23-101 Trading Rules (NI 23-101) prohibits activities that are manipulative and/or deceptive, which could occur in connection with short selling.
IIROC requirements relevant to short selling are contained in the Universal Market Integrity Rules (UMIR) and include:
- a requirement to mark all orders representing a short sale as either “short” or “short-marking exempt”;
- a requirement to report “Extended Failed Trades” to IIROC;
- a requirement that, if an Extended Failed Trade report is filed with IIROC, further short sales generally cannot be made without having made prior arrangements to borrow the securities necessary for settlement;
- the ability for IIROC to designate a security as a “Pre-Borrow Security”; and
- the ability for IIROC to designate a security as a “Short Sale Ineligible Security”.
IIROC also monitors for potentially abusive trading activity and has additional alerts that detect changes in the pattern of short selling for a particularly security.
The Staff Notice acknowledges that compared to that of foreign markets, the Canadian regulatory approach “makes it easier to conduct an activist campaign that unfairly targets Canadian issuers”. Despite this perception, the Canadian regulators maintain in the Staff Notice that Canada’s regulatory regime is consistent with the principles articulated by the International Organization of Securities Commissions (IOSCO) for the effective regulation of short selling and that, to date, they have not received sufficient evidence to justify a different regulatory response.
Further feedback is nonetheless invited on the following:
- The “tick test” repealed in 2012 by IIROC which required that the short sale not occur at a lower price than the previous trade, subject to limited exceptions. Several commenters have recommended that the CSA review the impact that the removal of the tick test has had on the market.
- Concerns that market participants may engage in short selling where they enter short sale orders without an intention to settle the resulting trades on settlement date, purely as a means to drive down the price of an issuer’s securities. On this point, the Staff Notice asks if the existing regulatory regime around pre-borrowing should be strengthened, and if so, how. They also ask for a cost-benefit analysis of any strengthening.
- IIROC’s extended failed trades requirement states that a failed trade is not reportable until ten trading days following the settlement date. Noting stakeholder concerns that this timeline is unnecessarily long for an unsettled trade to be reported and should be shortened, the Staff Notice asks for stakeholder input.
- IIROC publicly discloses short positions by publishing the Consolidated Short Position Report twice monthly. In contrast to other jurisdictions (such as the European Union and Australia), however, there are no obligations to disclose information on the short position of particular accounts. The Staff Notice explains that the regulators are reviewing international initiatives to enhance reporting and disclosure requirements, and request input from stakeholders and as to whether additional disclosures should be implemented for junior issuers.
- Lastly, the Staff Notice asks for feedback on mandatory close-out or buy-in requirements similar to those in the U.S. and the European Union and whether they would be beneficial for the Canadian capital markets which have no such requirements.
The regulators are seeking comments and or responses to the above questions on or before March 8, 2023.
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