Proposed Guidance on UMIR Requirements Related to Short Selling and Failed Trades

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Executive Summary

The Canadian Investment Regulatory Organization (CIRO) is requesting comment on proposed guidance on requirements related to short selling and failed trades under the Universal Market Integrity Rules (UMIR) (Proposed Guidance). The Proposed Guidance is published concurrently with the proposed amendments respecting a reasonable expectation to settle a short sale (Proposed Amendments).  The Proposed Guidance provides additional clarity on the short selling regulatory framework in UMIR and helps Participants and Access Persons understand and comply with new and existing requirements.

The Proposed Guidance would clarify, among other things:

  • obligations of Participants and Access Persons before entering an order on a marketplace that upon execution, would result in a short sale
  • order marking requirements when entering an order for a short sale
  • what constitutes a failed trade
  • obligations of Participants and Access Persons after there has been an extended failed trade reportable to CIRO under UMIR 7.10.

Sections 1 to 3 of the Proposed Guidance address current requirements however section 4 of the Proposed Guidance specifically relates to the proposed UMIR 3.3 requirement to have a reasonable expectation to settle a short sale as outlined in the Proposed Amendments.

All rule references in the Proposed Guidance are to UMIR and the Investment Dealer and Partially Consolidated Rules (IDPC Rules) unless otherwise specified.

Appendix A sets out the text of the Proposed Guidance.


Appendix A — Guidance on UMIR Requirements Related to Short Selling and Failed Trades

GN-URPart3-24-0001

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, all rule references are to UMIR and the Investment Dealer and Partially Consolidated Rules (IDPC Rules) unless otherwise specified.

Table of contents

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  , a Participant or Access Person must arrange to borrow the securities needed to settle any resulting trade before entering an order to sell short on a marketplace.  

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”  ), regardless of whether the Participant or Access Person actually reported the extended failed trade to CIRO (EFTR) as required.  

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.

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.  

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   below.

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 a 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   (RMCS) to change the order marker from a long sale to a short sale.

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 there is no other source of securities, and the trade became an extended failed trade, this failure to settle would be considered an intentional failure by the client or non-client under UMIR 3.4(2)(b).   See also Q&A #3 below.

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.   Unless the trade on the marketplace was executed as a Special Terms Order   using a different settlement date, all trades executed on a marketplace must currently settle by T+2 (which is expected to change to T+1 after May 27, 2024)  .

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).  

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+12 (expected to move to T+11 after May 27, 2024) 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+12 (or T+11 after May 27, 2024) 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)  , that the reason for the prior failed trade was not the result of any intentional or negligent act of the client or non-client.

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 provided attestations to several executing Participants that they had 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 were based on an outdated easy-to-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  . If no consent from CIRO was obtained, the pre-borrow requirements would apply to all future principal short sales in the same security, regardless of whether the prior extended failed trade was subsequently settled.
  • 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 establish a reasonable expectation to settle before entering an order that would result in a short sale on a marketplace. Documenting how a reasonable expectation to settle prior to order entry was established would help Participants and Access Persons demonstrate compliance with this positive obligation.  

Whether a trade ultimately settles would not support the claim that a reasonable expectation to settle the trade existed before the time of order entry. Therefore, 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.

By settlement date

UMIR 3.3 requires a seller to have a reasonable expectation to settle on the date contemplated on the execution of the trade. Unless a trade on the marketplace was executed as a Special Terms Order   using a different settlement date, all trades executed on a marketplace must currently settle by T+2, which is expected to change to T+1 on May 27, 2024.  

Trades that do not settle by the date contemplated on the execution of a trade will be considered a “failed trade”  . In order to settle a short sale under the UMIR 1.1 definition of a “failed trade”, the Participant or Access Person must make:

  • 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  . This means that a trade will still be considered a failed trade if the seller failed to deliver the securities as required, regardless of whether the trade settled through netting and novation by the CDS Clearing and Depository Services Inc. (CDS).

4.2 What are the factors that affect the ability to demonstrate a Reasonable Expectation to Settle?

The following sections set out 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 demonstrate 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.

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 cannot establish a reasonable expectation to settle the resulting trade on 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 can a Participant or Access Person demonstrate a Reasonable Expectation to Settle?

One way to demonstrate a reasonable expectation to settle under UMIR 3.3, is to rely on easy-to-borrow lists   of securities, provided that such lists only include securities that are readily available.

Below we have set out some considerations on how Participants and Access Persons can compile, monitor and use easy-to-borrow lists:

How to Compile an Easy-to-Borrow List?

Participants and Access Persons may consider the following factors when determining the securities to include on an easy-to-borrow list:

  • liquidity parameters, such as those used to define highly-liquid securities   in UMIR 1.1
  • avoiding securities that have 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.

Importantly, a particular security that has not been determined to be hard-to-borrow, does not automatically mean it can be assumed to be easy-to-borrow.

How to Monitor an Easy-to-Borrow List?

In order for a Participant or Access Person to reasonably rely on an easy-to-borrow list to comply with UMIR 3.3, the availability of securities on such lists must be monitored and updated on a regular basis.

How to Use an Easy-to-Borrow List?

We expect that Participants and Access Persons would only rely on easy-to-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 that securities included on these lists are readily available.

For example, if a Participant or Access Person obtained an easy-to-borrow list from a dealer, but it does not trade or clear through that dealer and the dealer has not agreed to make securities on that list 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 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 ensure compliance with reasonable expectations to settle any resulting trade on settlement date.

As a best practice, Participants 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   by the Securities and Exchange Commission (SEC) in the United States or the EU Short Selling Regulation (SSR .

4.6 How could Persons with Marketplace Trading Obligations or those using the short-marking exempt order marker demonstrate a Reasonable Expectation to Settle?

Proper use of the short-marking exempt order   marker, including by entities with Marketplace Trading Obligations   trading in their securities of responsibility, would indicate there is a reasonable expectation to settle. This is because entities with Marketplace Trading Obligations would not, in the ordinary course, have more than a nominal position at the end of a trading day, whether long or short, in any particular security.

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.

5. Documentation requirement

Participants or Access Persons must document compliance for the CIRO rule requirements discussed above.   These records should be maintained in durable and accessible form, for a minimum of seven years from the date the record is created.  

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 Rule 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 08-0143Provisions 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 23-0054Amendments to facilitate the investment industry’s move to T+1 settlement (April 20. 2023).
  • CIRO Notice 24-0003Proposed Amendments Respecting the Reasonable Expectation to Settle a Short Sale (January 11, 2024).
24-0004
Type: Rules Bulletin >
Request for Comments
Distribute internally to
Institutional
Internal Audit
Legal and Compliance
Operations
Retail
Senior Management
Trading Desk
Training
Rulebook connection
IDPC Rules
UMIR
Division
Investment Dealer

Contact

Other Notices associated with this Enforcement Proceeding:

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