Late and complex guidance from regulators has left the markets unprepared and confused ahead of today's imposition of the first pan-EU rules on short-selling, according to brokers, traders and investors.
The far-reaching regulation, which was finalized in March, imposes tough disclosure requirements for investors who place large bets that the prices of EU-listed shares or bonds will fall.
The legislation also tightens rules against "naked" shorting – selling shares without arranging to borrow them first – and bans investors from buying credit default swaps on debt issued by sovereigns in the 27-nation bloc unless they can show they are hedging a long position.
But investors and their lawyers have complained that the European Securities and Markets Authority, the pan-EU regulator, has failed to give them enough guidance on how to calculate the size of their short positions.
"It's a shambles," said Darren Fox, a partner at Simmons & Simmons who advises hedge funds. "People are crying out for clarity. I can't remember another piece of European legislation being implemented this badly."
Dealers are even angrier. The regulation contains important exemptions to the rules for market makers but Esma is not expected to issue final guidance on what counts as market making until later in November.
"The regulators aren't ready for this," said Paul Cluley, a partner at Allen & Overy who has been advising market participants. "Esma isn't ready. It is coming into force because there is a political will to be seen to be doing something, even if no one knows quite how, or indeed if, it will work."
The regulation also marks one of the first times that the EU has sought to regulate transactions outside its borders – any shorting of a security with a primary listing in the EU is covered.
"This is really the first time that non-US regulation has impacted directly [on] US market traders," said Stephen Wink, partner at Latham & Watkins, the law firm. "I think this was a real surprise for many folks in the US market."
The UK's Financial Services Authority recently set up an application procedure for institutions that think they fit under the market-making exemption but the City watchdog has told banks and brokers to look to Esma to define what is covered.
Esma officials acknowledged that the guidance on market makers would not be ready in time. But they noted that the EU regulator has already published two sets of frequently asked questions and downplayed the importance of the market-maker guidelines.
"The requirement regarding the market-maker and primary-dealer exemption is already set out in the regulation," Esma said in a statement. "The proposed guidelines, which are currently under discussion, are aimed at clarifying and explaining the application of the regulation, but do not change its scope."
But dealers said they needed the final guidelines to see whether Esma had responded to complaints that the draft version was significantly more restrictive than the regulation itself.
"There isn't total clarity on how that market-making exemption will work," said Richard Metcalfe of the International Swaps and Derivatives Association. "There is still debate about what actually constitutes market making and whether that has to be a frequent activity. That shouldn't be the case."
The new law also calls for the EU watchdog to opine whether national regulators are being reasonable when they impose emergency bans on selling equities and bonds short. Esma is expected to issue its view of the current Greek and Spanish bans this week.