On August 26, 2013, the Financial Services Agency of Japan promulgated the final text of the amendments to the existing rules and regulations governing short sale transactions (the “Amendments”). The effective date of the Amendments will be November 5, 2013.
This Client Alert is a summary of the key changes set forth in the Amendments.
1. Inclusion of Short Trades made on Proprietary Trading Systems.
Currently, the rules and regulations governing short sales in Japan are only applicable to trades made on exchanges.1 However, as a result of the Amendments, the scope of the existing rules will be expanded and short sales made on Proprietary Trading Systems (“PTS”)2 will also be subject to the existing short sale regulations. Specifically, short sales made on a PTS will be subject to the following rules: (i) the prohibition of “naked” short selling; (ii) “short sale” flagging requirements of the trader (i.e. identifying whether the sale is long or short to the broker); (iii) the Uptick Rule;3 (iv) Short Sale Balance Ratio reporting and disclosure requirements; and (v) the prohibition on the use of shares acquired through a public offering to close out short positions created through short sales made during the offering period.
2. Changes to the Uptick Rule (Introduction of the Trigger Method).
The Amendments also effected changes to the Uptick Rule. Currently, the Uptick Rule applies to all short sales in Japan. However, under the Amendments, in the case where the security is only listed on a single exchange, the Uptick Rule will only be triggered when the price of the traded security drops 10% or more below the previous trading day’s closing price and, in such case, the Uptick Rule would apply on trades made on that exchange until the end of the immediately following trading day.
Furthermore, where the security is listed on multiple exchanges, the effective term of the Uptick Rule will vary depending on which exchange the trigger was hit.
If the Uptick Rule is triggered on the “principal” exchange:4 (i) with respect to the “principal” exchange, the Uptick Rule will be applicable both on the trading day on which the trigger was hit and until the end of the immediately following trading day; and (ii) with respect to other non-”principal” exchanges, the Uptick Rule will only be applicable to such non-”principal exchange” on the immediately following trading day (i.e. excluding the trading day that the Uptick Rule was triggered on the “principal” exchange).
If the Uptick Rule is triggered on an exchange that is not the “principal” exchange, the Uptick Rule will only apply on such exchange until the end of the trading day on which the trigger is hit and the Uptick Rule will not apply to any other exchange (including the “principal” exchange).
As a matter of practice, it appears that the relevant exchange will be responsible for issuing public announcements regarding when the Uptick Rule trigger has been hit with respect to any given security. However, the Japan regulators have not provided any information as to the precise manner by which the exchange will make such public announcement.
3. Changes to the Short Sale Balance Ratio Reporting and Disclosure Regime.
Under the Amendments, numerous changes are made to the laws requiring traders to report their Short Sale Balance Ratio in a listed security. A summary of those changes is set forth in the chart below.
|Effective Term:||Temporary (recently being renewed for defined six month terms).||Permanent.5|
|Application:||Trades made on an exchange.||Trades made on an exchange or on a PTS.|
|Short Sale Balance Ratio Thresholds:||Tier: 0.25% or greater6
The trader is required to make a report to its broker and this information would be made available to the public by being posted on the website of the relevant exchange.
Tier 1: 0.2% to less than 0.5%
Tier 2: 0.5% or greater
|Fluctuation Report:||A Fluctuation Report is required for any change in the Short Sale Balance Ratio of the filer.||A Fluctuation Report is required only for changes of 0.1%7 or more in the Short Sale Balance Ratio of the filer.|
|Manner of Reporting:||The report is filed with the exchange through the broker with whom the filer made the relevant short trade that triggered the obligation.||The report is filed with the “principal” exchange through the broker with whom the filer made the relevant short trade that triggered the obligation, provided, however, if such broker is not a member broker of the “principal” exchange, such broker may be required to further deliver such report to a member of the “principal” exchange.|
|Contents of the Fluctuation Report:||The Fluctuation Report includes the following information: the name and address of the trader, issue code of the security, the name of issue, calculation date, the trader’s Short Sale Balance Ratio, and outstanding short position (shares and units).||In addition to the current disclosures, under the Amendments, the Fluctuation Report must also include information on the calculation date and the Short Sale Balance Ratio as stated in the previous report.|
|Calculation Methodology of Short Sale Balance Ratio:||(no specific provision)||
For the Short Sale Balance Ratio calculation, the trader must use:
(i) its outstanding short sale balance at the end of the trading day; and
(ii) the total issued and outstanding shares of the issuer as of the calculation day (i.e., the day on which the trader crossed a threshold).
4. Amendments to the “Exempted Trades” Provisions of the Short Sale Regulations.
Under the existing rules, certain types of trades are exempt from the short sale rules and regulations (“Exempted Trades”). The Amendments have further expanded the scope of the Exempted Trades and the Amendments include the following types of trades:
(1) Hedge sale of ETFs (including below) for a merger, share split, etc.:
(2) Arbitrage transactions between an exchange and a PTS or between two PTSs.
Furthermore, one of the existing Exempted Trades was revised to avoid perceived potential abuses.
Currently, the sale of a yet settled security on the market is classified as an Exempted Trade and not subject to the various short selling rules and regulations. Using this exemption, a practice developed whereby traders entered into short sale transactions outside of the market with their brokers and where such brokers subsequently sold such shares on the market prior to settlement. Under the current laws, both of the foregoing trades will not be subject to the short sale rules as: (1) the short sale of the trader with its broker is an off market trade and therefore outside of the application of the short sale rules; and (2) the subsequent trade of the broker is also outside of the scope of the short sale regulations as such trade is deemed as an Exempted Trade as discussed above.
In response to this perceived market abuse, under the Amendments, if a broker, acting in collusion with a trader that is seeking to engage in a short sale, buys securities from such trader instead of taking a short sale order (or brokering the trader’s order to execute the short sale) from such trader and the broker then sells such unsettled securities on the market (to be settled by securities acquired and delivered by the trader), the broker may no longer be able to rely on this exemption (i.e. the sale of an unsettled security on the market). In other words, if it is deemed that there is collusion between the trader and the broker, it is possible that the trades of both or either of the trader and the broker will be deemed as a short sale, as the case may be.
The Investment Management Group of Bingham McCutchen Murase, Sakai Mimura Aizawa – Foreign Law Joint Enterprise is happy to provide any requested additional information regarding the application of the Amendments.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:Wells-Christopher
1In this Client Alert, the regulations regarding OTC traded securities are omitted as currently there are no longer OTC registered securities in Japan.
2This would apply to a PTS using an auction, client order matching or bid/offer price indication method.
3Where applicable for the trade in question, traders are prohibited from engaging in a short sale of a listed security unless the sale was executed at a price above the immediately preceding trade’s execution price if the price was dropping (the “Uptick Rule”).
4With respect to securities listed on numerous exchanges, the “principal exchange” is the exchange on which the volume of the transactions with respect to the security (or other securities if no such security is available) is the highest during the past six months.
5The ban of naked short sale was also temporary measure both introduced in October 2008 and such ban will also become permanently applicable.
6Another threshold of more than 50 trading units will be applicable to both current and amended short sale regulations.
7The fluctuation will be calculated by the truncated numbers to the 1st decimal place.
This article was originally published by Bingham McCutchen LLP.