Short selling reforms are a long time coming

IT doesn't smack of good planning to make laws retrospectively, particularly in relation to the knotty subject of short selling.

But a push by most of the major stakeholders looks set to help construct what should be a clear and transparent short-selling regime in Australia.

You may remember that the relevant minister, Senator Nick Sherry, had been planning to introduce a bill to parliament tightening up on definitions of short selling when the whole process was fast-tracked in September by ASIC chairman Tony D'Aloisio.

He used his powers to close a loophole in the regulations and left it to parliament to draft the law later. That capped off a crackdown that started on Friday, September 19, with a ban on "naked" short selling, and by the end of that weekend had become a ban on all forms of short selling.

Mr D'Aloisio admitted last week that events at that time in September had moved so fast, with the US and British jurisdictions looking set to impose bans that left Australia vulnerable, that the full ban became the best option.

The definitional ambiguity that required a tweak in the law was that some covered short sellers -- traders who had borrowed stock to cover their short positions -- had been maintaining that such an arrangement wasn't a short sale at all, and so hadn't been reporting it to their brokers as required.

Markets have suffered horribly since September but we're nevertheless back to a ban aimed solely at short selling financial stocks, which will stay in place until mid-January.

A lively panel discussion late last week at the Australian Investor Relations Association annual conference saw some arm-wrestling about exactly how stock lending and short selling should be reported, but it turned out that even the stock-lending industry, which has been held up as a recalcitrant, has been working with the Government to get a workable law together.

Stewart Cowan, who runs JPMorgan's custodial operations in Australia, said that ASLA, the Australian Stock Lending Association, had been talking with regulators and the Reserve Bank to devise a way of reporting in a meaningful way not only short-sold stock but also lent stock.

At the moment there is no information available to normal mortals in Australia on how much of any stock has been lent by custodians to short sellers. A British consultancy called Spitalfields Advisers and its subsidiary Data Explorers are reportedly the "Fort Knox" of stock lending information, shared with institutional clients prepared to pay for it. But in Australia we're not so lucky, having only a new short-selling reporting service instigated by ASIC and published by the ASX on its website that identifies only the short positions entered during the day of the report.

Everyone involved knows that that needs to turn into a more meaningful overall number, but it hasn't yet happened because there are some data-collection glitches to overcome before that's achievable.

Corporate governance activist Dean Paatsch, who was also on the panel, said the current system was "meaningless".

"The challenge is to make sure there's no time lag between the securities-lending data and the short-selling data appearing in front of investors," he said.

A bigger scale problem surfaced on Friday when asset allocation specialist Watson Wyatt, which works closely with the Future Fund, put out a global warning against stock lending.

Tim Unger, head of strategy at Watson Wyatt Australia, said a situation had now emerged where the downside risks to lenders might be "unacceptable". The big problem is not dropping prices, as you would expect: it's the risk of lenders not getting their stock back, as with library books but on a much bigger scale.

"It is imperative that institutional finds review their lending arrangements to ensure they fully understand the risk involved," said Mr Unger.

The firm identified counterparty risk, collateral and indemnification as the three key areas to watch, a bogyman warning aimed clearly at the institutional fund managers who pay for Watson Wyatt's services.

Speaking to The Australian, Mr Unger explained that "in almost every short-selling situation, collateral is put up by the borrower, either in the form of cash or stock". He said it was important to look closely at the stock being deposited.

Lenders were on the back foot even before Friday's warning.

"There are lots of other reasons to borrow," said Mr Cowan, fighting the unpopular corner.

"Dividend reinvestment plans, hedging options, convertible bond arbitrage and settlement all require stock borrowing," he said.

"The information can also be distorted as a result of on-lending of securities to other borrowers."

Mr Cowan said lenders want to establish "settlement efficiency and market transparency".

Clearly it's a complex issue but the fact that the stock lenders are inside the Government's tent on the law change is a major plus.

What about the short sellers?

Kim Ivey, chairman of the hedge fund body Alternative Investment Association of Australia, AIMA, made it clear that there's less friction out there than appears.

"The reporting framework is the traction point," he said, "but everyone agrees on the principles of the policy."

He said members of AIMA wanted to see short positions reported "no less frequently than every two weeks, the same as everywhere else in the world".

Mr Ivey warned that daily reporting of short positions encouraged "piggyback", or imitative trading, "and it leaves short sellers exposed to pressure from any large investor or groups of investors that wants to force them out".

He took a swipe at the current reporting system, saying that "interim measures designed to only capture daily trade data will give no transparency into the size of the short interest in a listed company, or the rate of change in the short interest.

"Reporting small daily trade data will significantly distort the actual shorting activity in a company's stock, as it fails to disclose position size and its implied impact on the stock's price behaviour," Mr Ivey said.

Clearly we're not quite there. Assuming Murphy's Law operates as usual, there's a good chance our new improved short-selling and disclosure laws will emerge blinking into the daylight just in time for the whole practice to be put out of fashion by the refusal of institutions to lend the necessary stock.

It was ever thus.


Source: theaustralian.news.com.au