Short-Selling Rule An Extra Burden For Brokers
17:51 EDT Monday, July 21, 2008
NEW YORK -(Dow Jones)- The government's move to curb "naked" short-selling in 19 securities has placed a burden on some of the very brokers it was intended to help, according to one Wall Street bank. Plus, the rule did little to stabilize share prices in the financial sector Monday.
The rule requiring short sellers to pre-borrow shares of Fannie Mae (FNM), Freddie Mac (FRE), Lehman Brothers Holding Inc. (LEH) and 16 other financial stocks officially took effect on Monday.
One executive at a Wall Street bank said there was no problem accessing the shares of the 19 companies to borrow Monday. There were some logistical complications, however. Generally, brokers "locate" shares available to borrow that are then borrowed at the settlement of the trade - typically three days later. When there are no shares available to borrow on its own book - typically in a proprietary account, or hedge fund - the bank borrows them from a custodian like State Street or Bank of New York.
To comply with the new rule, the bank had to borrow the shares as soon as the trade was ordered, effectively "fast-forwarding" the management of inventory from the settlement date. That created two problems: for statistical arbitrage clients, a trade could take minutes as the broker scrambled to get a commitment, rather than milliseconds. And, the bank itself had to pay the custodian it was borrowing the shares from up front, even though it wouldn't get paid by its client until the settlement date.
"We have to pledge cash collateral to our lenders, and have to raise cash from our treasury department," the executive said. "I don't think the SEC's intention was to cause a funding burden, but it has done so in a minor scale."
If the rule is extended to the broad market, as the SEC said it may be, the executive said there could be concern about the extent of the extra financial burden on brokers.
In the meantime, the rule has hardly achieved the desired effect of stability.
What looked like short sellers buying back their bets lifted many of the stocks higher last week and early in Monday's session, but most finished the session in, or near, the red.
Shares of mortgage-finance giant Fannie Mae were up as much as 38% earlier Monday, before closing up only 5.5% at $14.13. Shares of Freddie Mac, the smaller of the two mortgage-finance giants, fell 4.7%. Volume moderated from last week, but remained heavy, with about 106 million shares of Fannie Mae trading, compared with 410 million on July 10, and 11 million on July 3. About 95 million shares of Freddie Mac traded, compared with about 397 million on July 11.
Some of the gains recently may have been positioning ahead of the rule: "If you're short and you know everyone's got to cover, you're going to try and beat the herd," said Christopher Colarik, portfolio manager for Glenmede Investment Management in Philadelphia.
Among the broker dealers, shares of Lehman fell 4.1% to $18.32 after trading as high as $21.21 after the open. Morgan Stanley (MS), Goldman Sachs (GS) and Merrill Lynch (MER) all shed gains, too. Another red herring that may be influencing the financial stocks: oil. Oil fell precipitously last week, driving some buyers out of commodities and into financial stocks. That's because many of the same hedge funds and traders who were selling financials short were buying oil and commodities. On Monday, oil was back on the rise, as financial stocks were on the wane.
"I think we are close to the end...of this bear-market rally," said Lorenzo Di Mattia, manager of hedge fund Sibilla Global Fund. "I didn't hear of any specific covering for the new rule, but I do hear people forced to cover to reduce losses on the shorts, or to cut exposure on shorts that are impossible to manage."
"Some long-short equity guys who were long energy, short financials, experienced volatility in their portfolio that was way higher than acceptable, so they need to cut regardless of their view of the market."
- By Geoffrey Rogow; Dow Jones Newswires; 201-938-5360; geoffrey.rogow@ dowjones.com
- Rob Curran, Dow Jones Newswires; 201-938-5176; robert.curran@dowjones.com
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(END) Dow Jones Newswires
07-21-08 1750ET
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