Nov. 19 (Bloomberg) -- Prime Minister Gordon Brown’s government proposed new powers to suspend “abusive” short selling deemed to be endangering the financial system.

The Financial Services Bill, laid before Parliament today and which applies to all financial firms, proposes giving the Financial Services Authority formal jurisdiction to impose “emergency restrictions” on short selling. The FSA would also have powers to force all institutions to permanently disclose short positions in markets.

The bill is the centerpiece of Brown’s legislative agenda announced by Queen Elizabeth II yesterday. Trailing in opinion polls with the election less than seven months away, Brown has tightened control over financial institutions blamed for triggering the sharpest recession since World War II.

“Along with governments around the world, we have learned important lessons about the weaknesses of global banking,” Chancellor of the Exchequer Alistair Darling said in a statement. “The bill we are introducing today is central to the government’s reform agenda.”

The bill gives the FSA tailor-made powers to ban such trades. The regulator already introduced an emergency ban on the short selling of around 30 financial companies’ shares in September 2008 through January 2009 at the height of the crisis after lawmakers blamed it for market instability. It invoked legislation that could leave it open to legal challenge.

Short Selling

Short selling takes place when hedge funds and other investors borrow shares they don’t own to then sell them in the hope that their price will fall. If they do, they buy back the shares, return them to their owners and pocket the difference.

The FSA last year used rules covering market abuse, which normally apply to insider trading, to temporarily ban short- selling. This was because market-abuse regulations apply to all investors worldwide, not just those based in the U.K. Breaches of the rule can result in bans or fines. Lawyers at the time suggested that the ban was open to legal challenge because what was normal market practice one day was outlawed the next.

The temporary ban, introduced on Sept. 18, 2008, came after HBOS Plc lost 37 percent of its value over three days. The bank is now part of Lloyds Banking Group Plc, which is 43 percent owned by the government.

“There were doubts about the legal basis for the FSA’s short-selling ban; the regulator will welcome a new power to make future emergency bans more robust,” said Ash Saluja, a London-based lawyer at CMS Cameron McKenna.

Broader Powers

While the ban was lifted in January, investors must still report short sales of the financial companies. Today’s rule change extends the powers to ban such sales to all U.K. stocks.

Similar plans are being drawn up across the European Union. The Committee of European Securities Regulators proposed in July that short sales of 0.1 percent or above or any company’s outstanding share capital would be privately reported to national regulators. If a further threshold of 0.5 percent was reached, public disclosure would be needed, CESR said.

Today’s bill also proposed a law requiring British financial firms to disclose salaries and bonuses given to their best-paid traders and executives. The bill applies to all firms regulated by the FSA, not just banks. It means insurers will also have to draw up plans for living wills and disclose bonuses.

‘Inappropriate Read-Across’

“As we feared, key provisions of the FSA’s new regulatory power in areas such as remuneration, living wills and disciplinary action are not restricted to banks but apply to all authorized firms such as insurance companies,” said Paul Edmondson of CMS Cameron McKenna. “Firms will be concerned about inappropriate read-across from the banking crisis.”

The Association of British Insurers, which represents 400 companies, said that it agreed with the principle of remuneration that didn’t encourage excessive risk.

“But it’s how they do it, there’s a danger of read- across,” said Erfan Hussein, an ABI spokesman. There are “sensitivities about being caught up in the banking backlash.”

The FSA can prohibit certain forms of bonuses, and enforce claw-back in all financial firms, under the proposals.

The Treasury will adopt a recommendation forcing banks to publish the number of executives it has in specific pay bands as well as the earnings and long-term remuneration for those people, a government official said, asking to remain unnamed because the bill isn’t yet published.

To contact the reporter on this story: Gonzalo Vina in London at gvina@bloomberg.net; Caroline Binham in London at cbinham@bloomberg.net

Last Updated: November 19, 2009 11:44 EST