Short selling needs regulation
By David Varney
FT.com site; Jul 21, 2002
Short selling - selling future options in expectation of a fall in prices - by hedge funds and the aggressive institutional trading arms of big investment banks has become a significant factor in the UK market. It has also been a contributory factor in the recent falls in world stock markets. Many in the markets and in industry believe that aggressive short selling is damaging the interests of long-term investors. David Prosser, chief executive of Legal & General, spoke for many last week when he called for short selling to be penalised by the tax system.
In my view, the important issue is not whether short selling per se is a bad thing. There are many sound reasons for believing it can have a positive role to play in creating more liquid and efficient markets. Short selling has been an established feature of the US stock market for many years.
An important, topical and legitimate issue, however, is whether there are adequate disclosure rules governing the activity of short sellers. This is particularly true of the UK stock market, where the disclosure regime for short selling is much less stringent than it is in other leading financial centres, such as New York, Hong Kong and Tokyo.
My own company, MMO, has direct experience of undisclosed activity by short sellers. In the eight months since the company's de-merger from BT, more than 1.6 times the number of shares it has in issue have been traded on the London Stock Exchange. Yet over the same period there has been little substantive change in the names on our shareholder register. The obvious implication is that the shares have been lent to hedge funds and other institutional traders to enable them to trade. (It is right to question whether the institutions that engage in stock lending to hedge funds are behaving in a prudent or responsible way, given that such lending may work against their own interest and that of those whose money they manage.) While we are entitled to monitor the activity in our shares, the problem is that we are unable to do so effectively as far as short sellers are concerned. Because of the woeful inadequacy of the disclosure rules relating to short selling in this country, we cannot say with certainty who has been carrying out this short selling, or the scale of the short interest in our stock. In my view, this cannot be healthy for the working of the market, or inspire investor confidence. Investors have a right to know who has been going short of shares in companies they own and also, I would argue, to be told on a daily basis what the level of short interest in their stock currently is and not simply the aggregate figure for the London market.
Under the disclosure regime for shareholdings in this country, as set out in the Companies Act and the Takeover Code, significant shareholdings have to be disclosed when they exceed a certain threshold (3 per cent in the case of the Companies Act, 1 per cent in situations where the Takeover Code applies).
Yet the glaring anomaly is that short sellers do not have to make any such disclosure, even if their short positions exceed the limits at which shareholders have to disclose their holdings.
This loophole puts the UK in stark contrast to the regulations that apply in other markets, where short selling cannot be done in such a discreet or unpoliced fashion.
In the US, for example, in order to protect investors against concerted market action by aggressive traders, short sellers are bound by the uptick rule - whereby a stock can only be sold short above the last price traded - imposed by the Securities Exchange Act. The New York Stock Exchange also publishes a monthly report, widely followed by analysts, that details the short interest in all leading quoted stocks. In Hong Kong, regulations govern which shares can be shorted, as well as the mechanics of short selling by an uptick rule. Short interest positions are disclosed daily. The regime in Tokyo combines elements of both the US and the Hong Kong regimes. Since March this year, aggregate information about short positions has been published monthly.
All these initiatives reflect the concern of regulatory authorities that persistent short selling should be disclosed appropriately and that this will help to make markets more transparent. The regime in Hong Kong was tightened as recently as 1998 following a particularly heavy raid by hedge funds and others on the local market.
Nobody would argue that short selling does not have a place in the stock market but it needs to be transparent and those who engage in such practices should be both visible and accountable for their actions.
If London wants to maintain its position as one of the world's leading financial centres, we need to be sure that our regulatory procedures in this area lead rather than lag behind best practice elsewhere.
The writer is executive chairman of MMOý |
