Guidance on UMIR Requirements Related to Short Selling and Failed Trades
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Executive Summary
The Canadian Investment Regulatory Organization (CIRO) is publishing guidance on requirements related to short selling and failed trades under the Universal Market Integrity Rules (UMIR). This Guidance Note further clarifies how Participants and Access Persons should comply with these requirements in a series of frequently asked questions and responses.
In this Guidance Note, all rule references are to UMIR and the Investment Dealer and Partially Consolidated Rules (IDPC Rules) unless otherwise specified.
Questions and Answers
1. What should a Participant or Access Person consider before entering an order for a short sale?
At a minimum, a Participant or Access Person should take the following into account before entering an order on a marketplace that upon execution would result in a short sale:
1.1 Short Sale Ineligible Security
A Participant or Access Person must not enter an order to short sell a security that CIRO has designated as a Short Sale Ineligible Security.
1.2 Pre-Borrow Security
If the security has been designated by CIRO as a Pre-Borrow Security
1.3 Prior Extended Failed Trade
Certain requirements apply once there has been a failed trade that is reportable to CIRO under UMIR 7.10 (“extended failed trade”
The considerations are different depending on whether the Participant or Access Person is acting as principal, or if the Participant is acting as agent for a client or non-client.
When trading as principal in the same security as the extended failed trade:
Before entering an order that would result in a short sale, a Participant or Access Person must:
- arrange to borrow the securities needed to settle any resulting trade, or
- obtain CIRO’s consent for the entry of such order(s)
The above requirements only apply if the short sale order is for the same security as the one that was part of the extended failed trade.
While CIRO’s consideration to provide consent to a Participant or Access Person for future short sales without pre-borrowing would be case-specific, when determining whether such consent is appropriate, CIRO would look at factors such as:
- reason for the initial failure
- reason as to why the Participant or Access Person is not able to arrange for a pre-borrow in the security, and
- rationale for the execution of the future short sale.
When acting as agent for the same client or non-client as the extended failed trade:
Before entering an order for the same client or non-client that would result in a short sale, a Participant must:
- make arrangements to borrow the securities needed to settle any resulting trade, or
- have made a reasonable inquiry and determined that the reason for the extended failed trade was not a result of any intentional or negligent act of the client or non-client
The above requirements apply to all short sale orders for the same client or non-client, and is not limited to the security that was part of the extended failed trade.
See also Q&A #3 below for further guidance.
1.4 Is there a reasonable expectation to settle the trade on settlement date?
Participants and Access Persons must have, before entering an order to short sell on a marketplace, a reasonable expectation of settling the resulting trade on settlement date.
- UMIR 3.3, being a positive requirement for a reasonable expectation to settle, and
- paragraph (h) of Part 2 of UMIR Policy 2.2, being a prohibition to sell without a reasonable expectation to settle.
Both requirements focus on having a reasonable expectation to settle prior to, or at, the time of order entry, and the positive obligation under UMIR 3.3 does not represent a higher standard when compared to the prohibition under UMIR Policy 2.2. For example, a seller may own shares from a financing that are subject to statutory resale restrictions and want to use those shares to settle a short sale trade. To have a reasonable expectation to settle on settlement date, the statutory restriction must expire prior to the settlement date of the short sale trade.
See section 4 below for further details regarding the technical requirement for a reasonable expectation to settle under UMIR 3.3.
See also Appendix A for a flowchart diagram that sets out some of the considerations before entering an order for a short sale on a marketplace.
2. What should a Participant or Access Person consider at the Time of Order Entry?
At the time of order entry, the Participant or Access Person must include the appropriate designation and/or identifier as required under UMIR 6.2. We include examples of marking orders as long or short sales
2.1 Where the seller has entered into an unconditional contract to purchase, or has tendered irrevocable instructions to convert or exchange another security into the security
In these circumstances, whether to mark the order as a long or short sale depends on the settlement date of the contract to purchase, convert or exchange the security into the security to be sold.
Where the settlement date for the contract to purchase, convert or exchange is on or before the settlement date of the short sale trade:
Participants and Access Persons should mark the order as a long sale on the marketplace, as this would not be considered a “short sale” under UMIR 1.1.
For example, if a client participates in a financing for freely tradable securities that closes on May 12 and later enters a sell order with a settlement date of May 14, then the order should be marked as a long sale. To have a reasonable expectation to settle the long sale, the seller should expect to receive the shares from the financing before the settlement date of the sell trade.
If after the trade has been executed on the marketplace as a long sale, there is an unexpected delay in the settlement of the contract to purchase, convert or exchange, there is no need to file a correction report through the Regulatory Marker Correction System
If the long sale described above fails to settle and becomes an extended failed trade, the Participant or Access Person must notify CIRO pursuant to UMIR 7.10.
Where the settlement date for the contract to purchase, convert or exchange is after the settlement date of the short sale trade:
Participants and Access Persons should mark the order as a short sale on the marketplace pursuant to the definition of a “short sale” under UMIR 1.1.
For example, if a client participates in a financing for freely tradable securities that closes on May 14, and enters a sell order with a settlement date of May 10, then the order should be marked a short sale.
To have a reasonable expectation to settle, the seller must rely on a source of available securities, other than those expected from the contract to purchase, convert or exchange, in order to settle the short sale on settlement date.
If the short sale described above failed to settle and becomes an extended failed trade, the Participant or Access Person must notify CIRO pursuant to UMIR 7.10.
3. After the Execution of the Trade
3.1 What constitutes a “failed trade” under UMIR?
UMIR defines a “failed trade” as a trade executed on a marketplace that did not settle on the expected settlement date when the trade was executed.
For further clarification, a trade is considered to be a “failed trade” when the seller does not deliver the securities as required on the expected settlement date, regardless of whether the trade ultimately settles through the netting and novation process by CDS Clearing and Depository Services Inc. (CDS).
The fact that a trade ultimately fails does not, in itself, mean that a Participant or Access Person did not have a reasonable expectation to settle on settlement date. See section 4 below for further details regarding the technical requirement for a reasonable expectation to settle under UMIR 3.3.
3.2 When is a failed trade reportable to CIRO?
Participants and Access Persons must notify CIRO after a trade on a marketplace fails to settle for 10 trading days past settlement date, which is currently T+11 unless the trade was executed as a Special Terms Order with a different settlement date, regardless of whether the trade has been settled in accordance with the rules or requirements of the clearing agency.
Therefore, unless executed as a Special Terms Order with a different settlement date, the reporting timeline of T+11 under UMIR 7.10 begins on trade date (i.e. the date on which the trade was executed on a marketplace), regardless of whether an accumulation or average price account is being used to facilitate the trade. For further clarification, where a Participant uses an accumulation or average price account to trade, the reporting timeline under UMIR 7.10 still begins on trade date (i.e. the date on which the trade was executed on a marketplace and not the date the trade is ultimately booked to the client account).
3.3 Reasonable Inquiry in relation to an Extended Failed Trade
When a Participant acts as agent for a client and executes a trade that becomes an extended failed trade, a Participant must:
- prior to the entry of an order that would result in a short sale, arrange to borrow securities to settle any resulting trade, or
- be satisfied, after making a reasonable inquiry under UMIR 3.4(2)(b)
The following sections break down the elements of the rule requirement under UMIR 3.4(2)(b), and provide examples of considerations under each element.
What is a “reasonable inquiry”?
A reasonable inquiry would include:
- contacting the client or non-client directly and asking about the reason for the failed trade at issue
- obtaining sufficient information from the client or non-client to determine if the prior failed trade was due to an intentional or negligent act by the client or non-client.
A Participant is expected to document the inquiry, including the Participant’s evaluation of whether the prior failed trade was the result of an intentional or negligent act of the client or non-client.
What might be considered an “intentional act”?
Intentional acts are those that are performed knowingly by the client or non-client. A malicious intent is not required. An administrative error or delay (such as delayed processing times by a transfer agent or custodian) would not generally be considered an intentional act of the client or non-client to not settle on settlement date.
Examples of failed trades arising from an intentional act of the client include:
Example 1: A client participates in a financing for securities that would be freely tradable upon close. The client intends to use shares purchased from the financing to settle a short sale, despite knowing that the closing date for the financing will occur after the settlement of the short sale trade. However, the client does not make other arrangements to ensure available securities, and the trade becomes an extended failed trade reportable to CIRO under UMIR 7.10.
In this case, CIRO would consider the failed trade to be the result of an intentional act of the client, and the Participant would need to arrange to borrow securities in order to act for the same client in future short sales in any security.
Example 2: A client wants to short sell a security knowing that the security has been deemed hard-to-borrow and provides attestations to the executing Participant regarding its ability to access available securities. Despite this, the client does not make arrangements to ensure securities are available to settle the resulting trade on settlement date, and the trade becomes an extended failed trade reportable to CIRO under UMIR 7.10.
In this case, CIRO would consider the failed trade to be the result of an intentional act of the client, and the Participant would need to arrange to borrow securities in order to act for the same client in future short sales in any security.
What might be considered a negligent act?
A negligent act from a client could include an action that may not have resulted from the intention of the client, but from the failure to take the steps that a reasonable person would take to ensure the settlement of the trade on settlement date. While bad faith is not required, a negligent act is one that could have been avoided with reasonable diligence. An administrative error or delay (such as delayed processing times by a transfer agent or custodian) would not generally be considered a negligent act of the client or non-client to not settle on settlement date.
Examples of failed trades arising from a negligent act of the client include:
Example 1: A client trades using multiple trading accounts across different Participants, and provides attestations to several executing Participants that they have securities available to settle the resulting trades. However, the client fails to keep track of their open short positions and some of these trades become extended failed trades reportable to CIRO under UMIR 7.10.
In this case, CIRO would consider the failed trades to be the result of a negligent act of the client, and each Participant where an account of the client had such an extended failed trade must make arrangements to borrow securities in order to act for the same client in future short sales in any security.
Example 2: A client wants to short sell a security, and provides attestations to the executing Participant that they have access to the relevant security. However, the client’s attestations are based on an outdated borrow list, and the client does not pay attention to the changed status of the security at the time of order entry. The resulting trade becomes an extended failed trade reportable to CIRO under UMIR 7.10.
In this case, CIRO would consider the failed trade to be the result of a negligent act of the client, and the Participant must arrange to borrow securities in order to act for the same client in future short sales in any security.
3.4 Applicability of pre-borrow requirements for extended failed trades involving an executing Participant and an originating dealer
If an extended failed trade was due to an intentional or negligent act of the client of an originating dealer, the executing Participant need only apply pre-borrow requirements for future short sales to that particular client of the originating dealer, rather than to the entire originating dealer as a whole.
As a best practice, the originating dealer should provide sufficient information to the executing Participant so that pre-borrow requirements can be appropriately targeted on orders from the specific client, and not the originating dealer as a whole.
3.5 Do pre-borrow requirements continue to apply even after an extended failed trade has been successfully settled?
Where a prior extended failed trade was:
- a principal trade, the Participant or Access Person would need to pre-borrow before shorting in a principal account the same security in the future, unless consent was obtained from CIRO
- a client or non-client trade, and the Participant determined the prior failed trade was due to an intentional or negligent act of the client or non-client, the Participant would need to pre-borrow all future short sales in all securities for the same client or non-client, regardless of whether the prior extended failed trade was eventually settled.
4. Additional Guidance Regarding the Positive Requirement for a Reasonable Expectation to Settle under UMIR 3.3
UMIR 3.3 requires a seller to have a reasonable expectation to settle any resulting trade on settlement date before entering an order for a short sale on a marketplace. We break down the various aspects of this requirement below.
4.1 What are the elements of the technical provision in UMIR 3.3?
Prior to order entry
UMIR 3.3 requires a Participant or Access Person to have a reasonable expectation to settle before entering an order that would result in a short sale on a marketplace. Documenting how the Participant or Access Person has a reasonable expectation to settle prior to order entry would help achieve compliance with this positive obligation.
For added clarity, whether there is a reasonable expectation to settle at the time of order entry remains separate and distinct from whether the resulting trade ultimately settles. The fact that a trade did not ultimately fail would not in itself be sufficient evidence to show that the seller had a reasonable expectation to settle prior to order entry.
Conversely, if a Participant or Access Person has a reasonable expectation to settle prior to order entry, that does not mean that the resulting trade cannot ultimately fail due to reasons outside of the control of the Participant or Access Person.
By settlement date
UMIR 3.3 requires a seller to have a reasonable expectation to settle a trade on the date contemplated on the execution of the trade. Unless a trade on the marketplace was executed as a Special Terms Order
A trade that does not settle by the date contemplated on the execution of the trade will be considered a “failed trade”
- available securities in such number and form, or
- arrangements to borrow securities in such number and form,
to permit settlement, regardless of whether the trade has been settled in accordance with the rules or requirements of the clearing agency.
4.2 What are some factors that would affect the ability to have a Reasonable Expectation to Settle?
The following sections set out some factors that would affect the ability of Participants and Access Persons to show a reasonable expectation to settle a short sale under UMIR 3.3.
Client History – Presence of Prior Failed Trades
A prior failed trade may negatively impact whether a Participant can have a reasonable expectation to settle future short sales for the same client in certain circumstances. This would include any prior failed trades that may not have persisted beyond ten trading days past settlement date to trigger an extended failed trade report to CIRO under UMIR 7.10. Ascertaining the reason for the previously failed trade with the client can help the Participant determine if there is an impact on a reasonable expectation to settle future short sales from that client.
When assessing client history where a Participant is executing trades for an originating dealer that is not a Participant
- the originating dealer provides sufficient information regarding settlement history for the client at issue, such that the executing Participant is able to make a reasonable determination for the purpose of having a reasonable expectation to settle a future short sale.
For example, if a Participant learns that the reason for the previous failed trade was due to an administrative error, this may not have a negative impact on a reasonable expectation to settle future short sales from that client.
However, if a Participant relied on a client’s attestation on having access to the necessary securities and that trade resulted in a failed trade under UMIR 1.1 due to the client’s negligence or false claim, it may not be reasonable to readily rely on such attestations from that client in relation to future potential short sales.
Whether a Security has been Determined to be “Hard-to-Borrow”
Before entering an order for a hard-to-borrow security that upon execution would result in a short sale, Participants or Access Persons may need to make additional arrangements to have a reasonable expectation to settle the resulting trade on settlement date. This may include pre-borrowing a sufficient number of securities to settle the trade where appropriate.
4.3 What if there is No Reasonable Expectation to Settle?
If a Participant or Access Person does not have a reasonable expectation to settle the resulting trade on the expected settlement date, the entry of a sell order on a marketplace that on execution would result in a short sale is prohibited.
4.4 How a Participant or Access Person can have a Reasonable Expectation to Settle
There may be a number of ways that a Participant or Access Person can have a reasonable expectation to settle under UMIR 3.3. One example of how a Participant or Access Person can have a reasonable expectation to settle is to rely on “borrow lists” that may include the concept of easy-to-borrow lists or hard-to-borrow lists (borrow lists).
Below we have set out some considerations on how Participants and Access Persons can compile, monitor and use borrow lists:
How to Compile a Borrow List?
Participants and Access Persons may consider the following factors when determining the securities to include on a borrow list:
- liquidity parameters, such as those used to define highly-liquid securities
- whether the security has a known history of delivery failures
- price thresholds that have been determined by the Participant’s or Access Person’s prime broker or custodian, and
- lack of any other condition(s) that would limit its availability.
How to Monitor a Borrow List?
In order for a Participant or Access Person to reasonably rely on a borrow list to comply with UMIR 3.3, such lists must be monitored and updated on a regular basis.
How to Use a Borrow List?
We expect that Participants and Access Persons would only rely on borrow lists that they have compiled or from dealers with whom they have established a formal relationship regarding clearing or settlement, as such dealers usually provide assurances to their clients on whether securities included on these lists may be readily available or hard to borrow.
For example, if a Participant or Access Person obtained a borrow list from a dealer which indicates certain securities are readily available, but it does not trade or clear through that dealer and the dealer has not agreed to make those securities available to the Participant or Access Person – the Participant or Access Person would not have a reasonable expectation to access those securities and in turn not have a reasonable expectation to settle the trade on settlement date. As a result, it would not be reasonable for the Participant or Access Person to rely on that list.
4.5 Do Self-Directed Orders (direct electronic access, routing arrangements, order execution only accounts) need to have a Reasonable Expectation to Settle?
Yes, before sending a self-directed order from a client to a marketplace that upon execution would result in a short sale, Participants must have a reasonable expectation to settle any resulting trade on the expected settlement date.
Participants or Access Persons that trade inter-listed securities may consider expanding the use of technological solutions that are already in use for compliance with other rules, such as Regulation SHO
4.6 How could Persons with Marketplace Trading Obligations or those using the short-marking exempt order marker have a Reasonable Expectation to Settle?
Proper use of the short-marking exempt order
Participants and Access Persons should refer to Notices 16-0028 and 16-0029 for further details on the proper use of the short-marking exempt order marker.
4.7 Where a Participant receives an order to short sell a security from an originating dealer, what are the obligations on the executing Participant with respect to a reasonable expectation to settle?
If the Participant is trading for another dealer that is:
- another Participant, then the executing Participant may rely on the jitney Participant to comply with UMIR requirements including having a reasonable expectation to settle on settlement date. This reliance is reasonable because all Participants are subject to the same requirements under UMIR.
- a CIRO investment dealer but not a Participant, then the executing Participant must generally treat the CIRO dealer as a client for the purpose of UMIR 3.3. However, as mentioned in the earlier sections, when determining client history (section 4.2 of this Guidance Note) or applying pre-borrow requirements (section 3.4 of this Guidance Note), the executing Participant may focus on a particular client of the originating CIRO dealer where appropriate.
- a foreign dealer equivalent that is subject to a similar or higher standard in their resident jurisdiction, then the executing Participant may rely on the foreign dealer equivalent’s documented compliance, for example, to the locate requirements under Regulation SHO in the United States.
5. Documentation requirement
Participants or Access Persons must document compliance for the CIRO rule requirements discussed above.
6. Applicable Rules
UMIR and IDPC Rules this Guidance Note relates to:
- UMIR 1.1, UMIR 2.2, UMIR 3.2, UMIR 3.3, UMIR 3.4 (previously UMIR 6.1(4)-(6)), UMIR 6.2, UMIR 7.1, UMIR 7.10, UMIR 10.16
- IDPC Rules 3803 and 3804.
7. Previous Guidance Note
This Guidance Note replaces the following:
- Guidance Note 22-0130 - Guidance on Participant Obligations to have Reasonable Expectation to Settle any Trade Resulting from the Entry of a Short Sale Order (August 17, 2022).
8. Related Documents
This Guidance Note is related to the following Guidance Note:
- Guidance Note 21-0122 – Marker Corrections and Use of the Regulatory Marker Correction System (July 12, 2021).
This Guidance Note is related to the following Bulletins:
- IIROC Notice 08-0143 – Provisions Respecting Short Sales and Failed Trades (October 15, 2008).
- IIROC Notice 12-0078 - Provisions Respecting Regulation of Short Sales and Failed Trades (March 2, 2012).
- CIRO Notice 23-0054 – Amendments to facilitate the investment industry’s move to T+1 settlement (April 20, 2023).
- CIRO Notice 24-0349 – Amendments Respecting the Reasonable Expectation to Settle a Short Sale (December 5, 2024).
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