The main issues for ISLA concerned the treatment of the sale of lent securities and the calculation of net short positions for reporting purposes. Regarding the former point, following consultation with members ISLA generally accepted ESMA’s proposal effectively to exempt sales of lent shares from the definition of a short sale where the lender issues a recall in time to effect settlement of the sale. Regarding the second issue, ISLA asked for clarification that long economic exposure through a securities lending agreement should be taken into account when calculation whether a net short position exists.
The main feedback is as follows:
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The associations support ESMA in trying to offer market participants guidance on how to interpret the concept of ‘correlation’. However, they do not support the introduction of a firm quantitative test for correlation. A level of 90 per cent ‐ as proposed by ESMA – is inappropriately high.
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A backward‐looking test for correlation, based on historic data, is too restrictive; in dynamic markets and particularly during periods of volatility it would prevent market participants from deploying hedging techniques based on developing or anticipated correlations between assets.
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Any guidance on the assessment of correlation must recognise that price correlation (whether historic or expected) will not always be an appropriate measure. Sovereign risk may be an indirect, or only partial, contributor to price movements in a given asset, and yet such asset may still serve as coverage for a CDS. This principle is specifically acknowledged in Recital 21 of the Regulation.
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A geographic restriction on the use of sovereign CDS for hedging purposes is not justified by the Level 1 Regulation, will prevent legitimate hedging strategies that nevertheless meet the tests of correlation and proportionality from being employed, and is thus a disproportionate restriction on the operation of the EU Single Market.
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The introduction of a mandatory time limit within which sovereign CDS position holders must offload a proportion of their position when it becomes partially uncovered is inappropriate, and has the potential to increase volatility in the sovereign CDS market significantly.
The associations are concerned that the provisions on grandfathering are unclear and will leave market participants facing considerable uncertainty about the legal status of particular trades.
Full response
© ISLA - International Securities Lending Association
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