Momentum growing for naked short selling ban
By Pauline Skypala
April 5 2009 09:59
Should naked short selling be illegal? The practice of seeking to profit from an expected fall in the price of an asset by selling shares you do not own without borrowing, or making arrangements to borrow them, is against Securities & Exchange Commission rules in the US and banned in Australia and Hong Kong.
Japan recently extended a ban on naked short selling first introduced in late October to the end of July, and the German financial services regulator did the same to the end of May, although its ban only applies to 11 financial companies
In fact, a trawl through the short selling regulations listed on Data Explorers’ website ( dataexplorers.com )suggests the UK is relatively rare in being pretty relaxed about the activity. A discussion paper put out by the Financial Services Authority in February looks at the option of outlawing naked short selling but concludes such a restriction would have “net negative impacts”.
It says exchange and clearing houses can deal with settlement failures and suggests problems would be better addressed by tightening settlement rules rather than bringing in a blanket ban on naked shorting.
However, judging by the report from Iosco, ( tinyurl.com ) the International Organisation of Securities Commissions, on the regulation of short selling, the FSA is out on a limb here. The report’s recommendations, published in March, aim to “eliminate gaps between the different regulatory approaches to naked short selling while minimising any adverse impact on legitimate activities, such as securities lending and hedging”.
The phrase rather suggests Iosco does not regard naked short selling as legitimate. The report talks about discouraging and deterring “abusive short selling behaviour”, which it defines as “those who short sold but with no intention of or reasonable plan for delivery”.
The Iosco task force was led by Martin Wheatley, who is also chief executive of the Securities and Futures Commission of Hong Kong, which happens to preside over one of the world’s most restrictive short selling regimes.
Since the Asian financial crisis of 1998, Hong Kong has only allowed covered short sales, it has an uptick rule that allows short sales only if the last sale price was higher than the previous price, and demands a full audit trail for covered short sales. Breaches can result in criminal prosecutions.
Ironically, Hong Kong was all set to discard the uptick rule, which effectively prevents short selling in a falling market, as recently as last September, on the view that it was competitively disadvantageous. The Lehman Brothers disaster put that idea to rest, and Mr Wheatley was able to boast that Hong Kong’s tight regulation of short selling meant there was no need for a ban.
Iosco’s recommendations were endorsed by the G20 London summit last week ( tinyurl.com ). The G20 working group report on enhancing sound regulation and strengthening transparency noted concerns raised during the financial crisis that short selling, “in particular naked short selling, contributed to market manipulation, securities fraud, and disorderly markets”.
The outcome is naked short selling looks likely to be history, or at least so restricted as to make it practically impossible, although the rules still have to be enforced.
The question of enforcement has been exercising commentators in the US recently, following press reports about a lack of enforcement actions in response to complaints about naked short selling. The story was linked to suggestions that naked short selling precipitated Lehman Brothers into bankruptcy, based on the number of failed trades.
However, some suggest the furore around naked short selling is misplaced. The FTfm columnist John Dizard, for one, argues the activity is a sideshow and the real culprit is the trade in credit default swaps. He explained his argument in a column titled “What enemies of short selling missed” last October. tinyurl.com
What this all goes to show is that the whole shebang has become so complicated no one really knows what is going on. Let’s get proper transparency and a standardised approach so people can see clearly whether naked short selling is a problem or an aid to market efficiency. Banning it is one way of finding out. Judging by the Hong Kong experience, there is no reason to believe it will damage market operations.
pauline.skypala@ft.com
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