European Union: EU Regulation On Short Selling: Impact On U.S. Issuers Of Structured Notes

On November 1, 2012, the regulation (the "Regulation")1 of the European Parliament and Council of the European Union on short selling and certain aspects of credit default swaps became effective.2 The Regulation may have a substantive impact on U.S. issuers of structured products linked to securities that trade in the European Union, as well as other participants in structured product transactions, and this article is intended to discuss some of these impacts.

The Regulation was conceived out of the need to harmonize the fragmented approach of different regulators throughout the EU towards restricting short selling and the use of credit default swaps ("CDS"), which limits the effectiveness of adopted measures and results in regulatory arbitrage. The Regulation seeks, in particular, to improve the transparency related to significant short positions and address risks of negative price spirals and settlement failures, especially in relation to uncovered or 'naked' short selling. Although the issuance of structured products does not necessarily relate to these issues, structured product transactions are among the transaction types impacted by the Regulation.

Scope of the Regulation and Key Provisions

The Regulation has been broadly drafted to include the short selling of equity securities admitted to trading on an EU regulated market or a multilateral trading facility, certain types of EU sovereign debt3 (as well as derivatives and structured product transactions referencing and providing exposure to these securities) and the buying of credit protection through CDS in relation to EU sovereign debt. As a result, structured products that reference relevant securities will potentially be affected by the Regulation.

The Regulation creates a two-tier disclosure regime of public and private disclosure of net short positions in relation to equity securities. The Regulation also introduces disclosure requirements for the shorting of EU sovereign debt and trading in naked sovereign CDS. Structured products linked to sovereign debt tend to be limited to the institutional market in the U.S.

The Regulation requires market participants to effect (by 3:30pm on the following trading day) a private notification of a net short position, calculated at midnight in the relevant EU member state at end of a trading day on which its net short position reaches or falls below 0.2% of the relevant issuer's issued share capital, and each 0.1% above that, up until 0.5%. A public notification must be made when the relevant entity's net short position at midnight in the relevant EU member state at end of a trading day reaches or falls below 0.5% of the applicable company's issued share capital, and each 0.1% above that.

The calculation of net short positions is required to take into account all long and short positions which the holder has in relation to the relevant shares or EU sovereign debt, as well as any other form of economic interest in those instruments. In particular, it is required to take into account interests obtained directly or indirectly through the use of derivatives (including options, futures and contracts for differences) and indices, baskets of securities and exchange traded funds.

In determining net short positions in relation to EU sovereign debt, a disclosing entity is also required to take into account its positions under CDS trades relating to the relevant EU sovereign debt issuer. Disclosure need only be made to the national regulator of the relevant sovereign issuer. There is no equivalent public disclosure requirement and the notification thresholds vary by member state.4 However, uncovered EU sovereign CDS entered into on or after March 25, 2012 are no longer permitted. Those trades entered into prior to March 25, 2012 may be held until the maturity date of the contract.

For purposes of the Regulation, it does not matter when the trade creating a particular long or short position was effected. An issuer's only concern is whether it has an open net short position on or after November 1, 2012. It is also worth bearing in mind that the Regulation allows any existing member state rules relating to short selling to remain in place until July 1, 2013. As such, it is important (for now) to be aware of any local member state rules which may apply in addition to the Regulation.

The Regulation also obliges holders of short positions to keep for five years records of their net short positions, as well as the gross positions supporting these net short positions. However, the requirement to identify short sales in (private) transaction reports to competent authorities, which was in previous versions of the Regulation text, has been deferred to the Commission in its consideration of amendments to the Markets in Financial Instruments Directive 2004/39/EC.

The Regulation applies to parties anywhere in the world, regardless of their jurisdiction of organization or operations. The Regulation also applies to transactions that are effected within or outside of Europe.

The Regulation does not apply to shares for which the principal trading venue is outside the EU. As a result, for example, a French company that has its primary market in Paris, but also trades to a lesser degree in ADRs on the New York Stock Exchange will be covered. In contrast, a U.S. company that has its primary market in the U.S., but also has some trading on the London Stock Exchange, will not be subject to the Regulation.

Types of Transactions Impacted: Issuers

A variety of typical U.S. structured note transactions will be subject to the Regulation.

For example, a U.S. issuer issues a registered structured note linked to the positive performance of the NYSE ADRs of a French company traded in Paris. The issuance of the note creates a "net short position" for the issuer. If the U.S. issuer enters into a corresponding swap transaction with an unrelated third party through which it passes along all of its exposure to the upside performance of the ADRs, the net short position will revert to zero. On the other hand, if it enters into the same swap transaction with an affiliated entity, the corporate group as a whole will retain that net short position. Of course, it's entirely possible that the related-party entity will offset some or all of its exposure to the ADRs through one or more transactions with other entities, and reduce the net short position.

Similar results arise from linking to an index or an exchange-traded fund that includes European securities. For example, the EURO STOXX 50 Index and the MSCI EAFE Index (and ETFs that track those indices) are common underlying assets for U.S. structured notes. As to each relevant European security within the index or ETF, the Regulation requires the issuer to recognize a portion of the principal amount of each relevant structured note as a short position in the relevant security, according to its weighting in the index or ETF.

Types of Transactions Impacted: Investors

Investors, particularly institutional investors, may enter into transactions that are regulated by the rules. For example, an investor with a particular market view may purchase a note that is linked to the negative performance of a particular stock or index. If the transaction is large enough, it can trigger the provisions of the Regulation. On the other hand, investing in a structured product that is bullish on a particular stock may offset a net short position that the investor otherwise may have.

Compliance Efforts

Needless to say, the Regulation creates a substantial compliance challenge for multi-national market participants. At any one time, these entities will have (whether directly, or through their affiliates) a wide variety of long and short positions in a large number of European stocks, and indices and ETFs that include European stocks. In some cases, the short position will arise from their issuance of a structured product. In other cases, the short position may arise due to its involvement in the hedging transactions for another issuer's structured products. These types of transactions need to be evaluated together with the myriad of transactions outside of the structured products world that the issuer may be undertaking. It seems inevitable that there will need to be new compliance units established (to the extent that this has not been done already) in order to track and match long and short positions across an institution's various affiliates and subsidiaries. This will likely be the case with respect to global institutions with multiple affiliates and branches and, to a lesser extent, institutions with narrower trading strategies (such as hedge funds).

Focus on Conflicts

In a recent issue of this newsletter,5 we noted that FINRA representatives were focused on conflicts of interest in relation to the structuring and sales of structured products. In the period since that speech by Susan Axelrod, Executive Vice President, Member Regulation Sales Practice, of FINRA, the focus on conflicts seems to have intensified. In a more recent speech delivered at the end of October,6 Axelrod emphasized that, in connection with the FINRA examination process, FINRA would continue to devote substantial attention to complex products offered to retail investors. She cited as examples principal-protected notes, non-traded REITs, reverse convertible notes, and other structured notes. In relation to complex products she advised that "Firms should also consider whether they have any conflicts—particularly where they maintain affiliations with the product issuer or where there is a compensation arrangement that creates a conflict." She also noted that firms should "identify potential conflicts and document their process for ensuring that they do not place their interest—or that of their brokers—before the clients."

Many of these same issues were raised in a presentation given by Carlo di Florio, Director of the SEC's Office of Compliance Inspections and Examinations.7 Di Florio highlighted conflicts of interest as a key area in connection with OCIE examinations. Di Florio identified a number of types of conflicts that are high priorities in connection with examinations. In this list, he included: "retail customers' interests potentially taking a back seat to various financial incentives of a broker-dealer or its representatives in recommendations and sales practices for new or risky products. This includes, for example, the retailization of complex instruments such as structured securities products...."

Structured product offering documents and marketing materials generally disclose the role of any affiliated parties in the transaction, and highlight the risk of potential or actual conflicts of interest as a result of these relationships. Likewise, the disclosures generally alert potential investors that the issuer's affiliated broker-dealer may be providing hedging arrangements to the issuer in connection with the note and/or engaging in hedging activities for its own account or in connection with other business activities. Participants in the structured products market may consider reviewing whether their internal sales and training materials also highlight these potential conflicts of interest. In connection with reviewing their policies and procedures to address FINRA Notice 12-03 on Complex Products, market participants also may want to ensure that their new product committees are charged with considering any actual or potential conflicts of interest that may arise in connection with "manufacturing" the product, entering into hedging arrangements related to the products, or distributing the products. Market participants also may want to evaluate whether it is appropriate to evaluate the terms of their various distributor arrangements, to the extent that these are significant, in connection with a review of potential conflicts of interest. As we highlighted in another recent issue, firms also may want to review their "window-cleaning" and other internal wall or information handling policies in relation to the manufacturing of structured products.

Revised FINRA Communications Rules: A Summary Table for Market Participants

As we approach the end of the year, and begin to plan for 2013, we remind readers that the effective date of FINRA's new offering communications rules is February 4, 2013.8 Accordingly, to help practitioners review the relevant requirements, and to help facilitate planning, set forth below is a table that summarizes the new requirements.

FINRA Communications Rules



  • FWPs that are red herrings (filed under Rule 433(d)(1)(ii) if distributed broadly, on an unrestricted basis ("underwriter FWPs"))
  • If used broadly or on an unrestricted site:
  • a brochure
  • a product description
  • website product discussions
  • preliminary term sheets


  • Preliminary Pricing Supplements (424(b) filings)
  • Final Pricing Supplements (424(b) filings)
  • Documents for certificates of deposit, bank notes, or 144A issuances
  • FWPs that are final term sheets, filed with the SEC


1 The Regulation may be found at the following link: .

2 For our firm's summary of the Regulation, please see our client alert, which may be found at the following link: .

3 To be covered by the Regulation, the sovereign debt must be issued by (i) the EU, (ii) a member state (including a government department, an agency or a special purpose vehicle ("SPV") of the member state), (iii) a federal member state, (iv) an SPV for several member states, (v) an international financial institution established by two or more member states, or (vi) the European Investment Bank.

4 Individual member country notification thresholds can be found at:

5 See .

6 See .

7 See .

8 For additional information relating to the new rules, please see our Structured Products, Volume 3, Issue 9:

9 Institutional communication:

  • written/electronic communications distributed or made available only to institutional investors
  • does not include internal communications
  • if member has "reason to believe" communication will be forwarded to retail investors, communication may be a "retail communication"

10 Retail communication:

  • any written/electronic communication distributed or made available to more than 25 retail investors within a 30-day period
  • generally includes advertisements, sales literature, reprints
  • sales scripts intended for use with retail customers

11 New 2210(c)(3)(E) includes retail communications concerning any SEC-registered security derived from or based on a single security, a basket of securities, an index, a commodity, a debt issuance or a currency.

12 FWPs filed by an underwriter under Rule 433(d)(1)(ii) in a manner that will result in broad unrestricted distribution must be filed with FINRA, such as brochures posted on a public site, publicly available website pages about structured products.

13 Correspondence: any written/electronic communication distributed or made available to 25 or fewer retail investors within a 30-day period.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Peter Green
Jeremy C. Jennings-Mares
Anna Pinedo
In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.