On February 17, 2020, the European Securities and Markets Authority (ESMA) published a short supervisory warning¹ expressing its concerns following “…very high volatility in certain US stocks, linked to a significant accumulation of net short positions and concerted action by some retail investors, based on information shared on social media. Although market rules and structures are different in the EU, it cannot be ruled out that similar circumstances may occur in the EU as well.”

ESMA’s statements are the first type of such supervisory warning following some very public developments and impacts on price activity in certain equity securities in the United States notably GameStop and possible market manipulation. In summary, a large number of retail investors using the Reddit chat forum and possibly other online message forums targeted specific stocks in which institutional investors had taken short positions. Retail investors, buying such stocks in large numbers carried out a “short-squeeze”², effectively meaning that holders of short positions have had to reverse out of those positions thereby contributing to higher volatility. Such higher volatility also triggered massive margin calls from clearing houses, which in turn prompted several retail brokerage firms to suspend transactions in the affected stocks. This has in turn prompted supervisory scrutiny from regulators around the globe.

US regulators have taken first steps to clarify their expectations and US legislators are set to hold hearings from February 18 onwards. The UK’s Financial Conduct Authority had also published a similar if not shorter statement compared to ESMA’s efforts.³ The European Parliament’s Committee on Economic and Monetary Affairs will hold an expert hearing on the GameStop case on February 23, 2021 with Steven Maijoor, Chairman of ESMA and Ugo Bassi, Head of the Financial Markets Division at the European Commission providing findings.⁴

ESMA’s statements

While ESMA’s supervisory warning welcomes increased retail market participation⁵ in stock markets, notably for achieving the goals of the EU’s Capital Markets Union, it cautions on the significant risks retail investors face when investing in stocks that are subject to very high price volatility. ESMA’s warning also reiterates the general importance of investors keeping in mind their investment objectives, the benefits of diversified investments and for investors to consider their the ability to bear losses notably in relation to trading strategies involving financial or instrument-based leverage which can accentuate losses.

ESMA also urges retail investors to carefully consider the accuracy, reliability and quality of information available to them, notably on social media and “other unregulated online platforms”. Chat forums and online message boards are at present unregulated and while it is conceivable that ESMA could monitor online behavior more closely if it suspects market manipulation, it is more likely that efforts will focus on brokerage firms, their communications with clients and general financial education/risk awareness efforts. Inappropriate chat forum usage has already been in the global supervisory spotlight due to IBOR and equally for FX rates.

ESMA states that it, along with National Competent Authorities (NCAs) in the EU Member States, will continue to analyze market events and consider adopting further initiatives aimed at “…preserving investor protection and market integrity as appropriate.” As set out in our January 2021 monthly newsletter⁶ while any further action is likely to focus on financial services firms, notably those that may be seen to be excessively gamifying trading, it is also conceivable that ESMA could issue further supervisory guidance to the market generally on postings on social media or other online behavior that may constitute market abuse.

Importantly, the EU Market Abuse Regulation states in Art. 12(1)(c) that market manipulation includes “disseminating information through the media, including the internet, or by any other means, which gives, or is likely to give, false or misleading signals as to the supply of, demand for, or price of, a financial instrument, a related spot commodity contract or an auctioned product based on emission allowances or secures, or is likely to secure, the price of one or several financial instruments, a related spot commodity contract or an auctioned product based on emission allowances at an abnormal or artificial level, including the dissemination of rumors, where the person who made the dissemination knew, or ought to have known, that the information was false or misleading.”

ESMA’s warning sets out the first steps at further clarity by stating that: “Discussing the opportunity to buy or sell the shares of an issuer does not constitute market abuse. However, organizing or executing coordinated strategies to trade or place orders at certain conditions and times to move a share’s price could constitute market manipulation.“

Moreover, ESMA warned more widely that persons posting information on social media or message boards/forums etc. about an issuer or a financial instrument should be careful about what they post as this could qualify as an investment recommendation and thus trigger a number of regulatory requirements. ESMA equally cautioned that the dissemination of such postings could constitute market manipulation.

It is also possible over the longer-term that ESMA could consider launching a targeted and/or wider reaching thematic review or even a Common Supervisory Action⁷ looking at financial service firms’ standards of communications and risk warnings (including with respect to market abuse and influencing investment decisions in general).

With the above in mind and given that other global regulators and legislators are looking at this most recent development brokerage firms will want to ensure they have systems and controls in place to comply with ESMA’s expectations.

Our Eurozone Hub lawyers are assisting a number of brokerage firms on their conduct of business compliance obligations and client communications. If you would like to discuss any of the items mentioned above as well as how these developments fit into the 2021 supervisory priorities of ESMA and other ESAs and NCAs, or how they may affect your business more generally, please contact any of our key contacts or the wider team from our financial regulatory practice.

1. Available here. ↩
2. A short squeeze may occur when a stock or other financial instrument’s price jumps sharply higher, forcing traders who had bet that this price would fall i.e. a short position holder, to have to buy the stock or financial instrument in order to prevent greater losses. The buy orders and resulting activity supports the upward pressure on the quoted prices. ↩
3. The FCA commented: "The FCA is aware of the situation and continues to closely monitor trading in UK markets. UK investors should take care when trading shares in highly volatile market conditions that they fully understand the risks they are taking. This applies to UK investors trading both US and UK stocks. Firms and individuals should also ensure they are familiar with, and abiding by, all regulations including the market abuse and short selling regimes in the jurisdiction they are trading in."↩
4. The hearing, on February 23, 2021 from 14h45 to 16h15 Brussels Time can be followed online here. ↩
5. Specifically younger day trades caught in lockdown with unused funds and time. ↩
6. See coverage on this development in our Eurozone Hub’s January 2021 edition of our monthly newsletter available here in which we summarized developments relating to GameStop and other U.S. listed securities as follows: “The use of technology and social media platforms by certain (retail-)investors to communicate on price movements or means of moving stock prices (mostly through a “short squeeze”) has come back into focus following highly volatile price action in certain shares including GameStop. A number of policymakers and regulators have expressed concern at this development and some supervisors have directed warnings to potential lawbreakers notably with respect to market abuse. Further action may also be directed towards those brokers that may come under supervisory scrutiny for “gamifying” share trading.”↩
7. See coverage from our Eurozone Hub available here and here. ↩