The AUSTRALIAN Pressure to act against naked short...

The AUSTRALIAN
Pressure to act against naked short selling.
Andrew Main, Business editor | September 18, 2008
PRESSURE on market regulators around the world to act against "naked" short selling of shares looks likely to rise, thanks to the current share market bloodbath in financial stocks, particularly in the wake of comments overnight from the UK Chancellor of the Exchequer, Alistair Darling.

After watching shares in UK bank HBOS drop by more than 21 per cent in one day's trading, he told the BBC: "I'm extremely anxious that we avoid a situation where people can manipulate markets, causing huge harm. That is totally unjustified."

Darling said the Financial Services Authority, the UK regulator, was studying the role of speculators in the market, and he indicated that the UK Government was preparing new rules to prevent such short selling.

There are two kinds of short selling: naked, where traders sell shares they have not bought or borrowed, in the hope they can buy them back "to close" at a lower price; and covered, where they have borrowed shares to cover their position.

Both types are permitted in most jurisdictions, but naked short selling is losing popularity among regulators, particularly since in July the US regulator banned it in 19 particularly vulnerable US financial stocks, including Lehman Brothers, now in Chapter 11 bankruptcy.

Lehman's surrender, which surprised some observers who had expected US Treasury Secretary Henry Paulson to bail it out, has dampened enthusiasm for shorting, because a naked short seller can find it very hard to buy back a bankrupt stock. Lehman stock was still trading at US30c a share last night, as Chapter 11 is the equivalent of life support.

In Australia, the minister for superannuation and financial regulation, Senator Nick Sherry, has had Treasury experts prepare amendments to Australia's short-selling laws that will be aimed at increasing the amount of disclosure by traders borrowing stock to do covered short selling.

Ian Matheson, the chief executive of lobby group the Australian Investor Relations Association, said his organisation was urging Sherry to outlaw naked short selling. It is currently allowed in Australia under tight conditions, including declaring the position to the ASX, but is much less prevalent than covered shorting.

"We are also seeking full disclosure of covered short selling and stock lending at the point of sale," Matheson said.

The main issue in Australia is seen by all major players to be the need to increase the transparency of covered short selling, since at the moment it is extremely hard to identify how much stock is out on loan, and for what purpose, never mind who's short and what's been borrowed to cover.

A recent declaration by Fortescue Metals Group that about 10 per cent of its stock was available for loan turned out to be a false alarm, since there was no proof it had been lent out.

More ominously, overseas hedge funds have been ignoring legally imposed inquiries from Australian brokers as to whether they are short or not, while traders here and overseas who borrow stock have been failing to declare covered short positions in the belief that such a sale is not actually a "short".

The new legislation will at the very least remove the "definitional ambiguity" that has been allowing that loophole. Traders hope the new legislation, which will also involve new regulations drafted with input from regulator ASIC, will force overseas hedge funds to declare their short positions correctly or risk having their stock frozen.

All share trades in Australia, both on and off market, have to be cleared through ASX Ltd's CHESS system.