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Thursday 11 March 2010
Rules on short selling must be calibrated
Short-selling, or the selling of stock not owned with a view to buying back later after prices have fallen, has suddenly sprung into regulatory focus in many countries in the past few weeks.
Short-selling, or the selling of stock not owned with a view to buying back later after prices have fallen, has suddenly sprung into regulatory focus in many countries in the past few weeks.
For example, the US Securities and Exchange Commission (SEC) a fortnight ago introduced Rule 201 which restricts short selling on a stock that falls 10 per cent on the day of the fall as well as the following day. At the 10 per cent point, shorting will only be allowed at a price above the national best bid for that stock. Rule 201 replaces the previous ‘uptick’ rule which was that short selling could be undertaken only when the last sale price for that stock ticked upwards.
In Hong Kong, the Securities and Futures Commission (SFC) last week proposed a new law requiring disclosure to the SFC privately of short positions that exceed 0.02 per cent of a company’s issued shares as well as any short position that exceeds HK$30 million (S$5.4 million) out of a company’s market capitalisation of HK$150 billion. This applies only to the 43 Hang Seng Index components and 40 stocks in the H-share index.
Meanwhile, the Committee of European Securities Regulators (CESR), which includes representatives of the regulator in each EU member state, last Tuesday issued a report to the European Commission recommending the introduction of a pan-European short-selling disclosure regime.
The recommendation is that interests of 0.2 per cent would trigger private disclosure to the regulator, while increments of 0.1 per cent would trigger further disclosure. After the position reaches 0.5 per cent and any additional increments of 0.1 per cent thereafter, public disclosure has to be made. Market-makers would be exempt, but all derivative interests would be included.
In the US’s case, the new rule comes after the SEC completely banned short-selling during the financial crisis, so clearly the move represents an attempt to tread a middle ground that would pacify those who believe short-selling is not to be blamed for the crash.
Naked shorting
Clearly, short-selling is high up on the list of things for regulators all over the world to study and there appears to be a desire to try and better regulate it.
At this juncture, it’s important to draw a distinction between covered and naked short-selling - the former is deemed acceptable (albeit reluctantly, in some quarters) because the seller borrows scrip to cover the trade, the latter is deemed wholly unacceptable because it comes with no accompanying scrip and so can wreak havoc with an exchange’s settlement systems.
In the US, for example, naked shorting is a problem and trades are known to fail fairly regularly. When the SEC imposed an outright ban on all short selling at the height of the financial crisis some two years ago, it encountered heavy criticism for interfering with market forces but the ban was actually targeted at naked short selling which had spiked up sharply at the time. Viewed in this light, that ban was wholly justified.
Here, the Singapore Exchange (SGX) prides itself as being one of only a small handful of exchanges worldwide that can fully guarantee settlement of all trades on schedule. In order to achieve this, it quite correctly has installed hefty fines for naked shorting. These fines have not gone down well with brokers and the investing public but they are unfortunately, wholly necessary.
In addition, SGX has stated a preference for a disclosure-based approach to the thorny issue of regulating covered short-selling, though it is still mulling over what needs to be disclosed. In this connection, a few important points must be noted.
First, too much regulation can be counterproductive. In the US, for instance, the new 10 per cent rule comes with a host of complicated qualifiers and exemptions, such as those for domestic arbitrage, international arbitrage, over-allotment and lay-off sales, riskless principal transactions and transactions on a volume-weighted average price basis.
Information overflow
Second, too much disclosure may result in the public receiving useless information. For example, if a disclosure threshold is to be imposed, then HK’s 0.02 per cent and Europe’s 0.2/0.5 per cent are ridiculously low barriers that will surely result in a deluge of daily notifications to regulators who would then have the headache of collating and disseminating these figures to the public. A much better level would be the 5 per cent currently required under the law for stock purchases.
Third, even if 5 per cent is decided upon as the correct limit, it may be necessary to introduce legislation to compel such disclosures because as it stands now, SGX has no authority under the law to force scrip lenders to reveal their positions. SGX itself runs a scrip lending business so it can provide some data on which stocks are being borrowed but it does not have the full picture. Partial disclosure in this case - like too much disclosure in the earlier example - would thus be of limited use to the investing public.
2 comments:
Rules on short selling must be calibrated
By R SIVANITHY
10 March 2010
Short-selling, or the selling of stock not owned with a view to buying back later after prices have fallen, has suddenly sprung into regulatory focus in many countries in the past few weeks.
For example, the US Securities and Exchange Commission (SEC) a fortnight ago introduced Rule 201 which restricts short selling on a stock that falls 10 per cent on the day of the fall as well as the following day. At the 10 per cent point, shorting will only be allowed at a price above the national best bid for that stock. Rule 201 replaces the previous ‘uptick’ rule which was that short selling could be undertaken only when the last sale price for that stock ticked upwards.
In Hong Kong, the Securities and Futures Commission (SFC) last week proposed a new law requiring disclosure to the SFC privately of short positions that exceed 0.02 per cent of a company’s issued shares as well as any short position that exceeds HK$30 million (S$5.4 million) out of a company’s market capitalisation of HK$150 billion. This applies only to the 43 Hang Seng Index components and 40 stocks in the H-share index.
Meanwhile, the Committee of European Securities Regulators (CESR), which includes representatives of the regulator in each EU member state, last Tuesday issued a report to the European Commission recommending the introduction of a pan-European short-selling disclosure regime.
The recommendation is that interests of 0.2 per cent would trigger private disclosure to the regulator, while increments of 0.1 per cent would trigger further disclosure. After the position reaches 0.5 per cent and any additional increments of 0.1 per cent thereafter, public disclosure has to be made. Market-makers would be exempt, but all derivative interests would be included.
In the US’s case, the new rule comes after the SEC completely banned short-selling during the financial crisis, so clearly the move represents an attempt to tread a middle ground that would pacify those who believe short-selling is not to be blamed for the crash.
Naked shorting
Clearly, short-selling is high up on the list of things for regulators all over the world to study and there appears to be a desire to try and better regulate it.
At this juncture, it’s important to draw a distinction between covered and naked short-selling - the former is deemed acceptable (albeit reluctantly, in some quarters) because the seller borrows scrip to cover the trade, the latter is deemed wholly unacceptable because it comes with no accompanying scrip and so can wreak havoc with an exchange’s settlement systems.
In the US, for example, naked shorting is a problem and trades are known to fail fairly regularly. When the SEC imposed an outright ban on all short selling at the height of the financial crisis some two years ago, it encountered heavy criticism for interfering with market forces but the ban was actually targeted at naked short selling which had spiked up sharply at the time. Viewed in this light, that ban was wholly justified.
Here, the Singapore Exchange (SGX) prides itself as being one of only a small handful of exchanges worldwide that can fully guarantee settlement of all trades on schedule. In order to achieve this, it quite correctly has installed hefty fines for naked shorting. These fines have not gone down well with brokers and the investing public but they are unfortunately, wholly necessary.
In addition, SGX has stated a preference for a disclosure-based approach to the thorny issue of regulating covered short-selling, though it is still mulling over what needs to be disclosed. In this connection, a few important points must be noted.
First, too much regulation can be counterproductive. In the US, for instance, the new 10 per cent rule comes with a host of complicated qualifiers and exemptions, such as those for domestic arbitrage, international arbitrage, over-allotment and lay-off sales, riskless principal transactions and transactions on a volume-weighted average price basis.
Information overflow
Second, too much disclosure may result in the public receiving useless information. For example, if a disclosure threshold is to be imposed, then HK’s 0.02 per cent and Europe’s 0.2/0.5 per cent are ridiculously low barriers that will surely result in a deluge of daily notifications to regulators who would then have the headache of collating and disseminating these figures to the public. A much better level would be the 5 per cent currently required under the law for stock purchases.
Third, even if 5 per cent is decided upon as the correct limit, it may be necessary to introduce legislation to compel such disclosures because as it stands now, SGX has no authority under the law to force scrip lenders to reveal their positions. SGX itself runs a scrip lending business so it can provide some data on which stocks are being borrowed but it does not have the full picture. Partial disclosure in this case - like too much disclosure in the earlier example - would thus be of limited use to the investing public.
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