Mumford_ AFR_20080301_Local short selling trends can be long on misery

Mumford_ AFR_20080301_Local short selling trends can be long on misery

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Unformatted text preview: _-. rnmuflvtrngvwexea-snsv mum ii'F/C _'MAK “Ia-.2 , 2.0.93" Local short selli The fate of ABC Learning - raises interesting questions, writes Glenn Mumford. he dramatic share price declines at ABC Learning during the week have again led to calls for a change in . the rules governing short selling. The problem for Australian ' regulators is that looking at short selling is akin to. looking at an iceberg. What you See-above the 7 surface is an Australian Securities Eachang‘e-sanciioned and supervised short-selling market. Hidden below the surface is a far larger, much less regulated shorting capability that has arisen 7 out of the stock-lending market. This past week hedge funds have again been labelled the culprit in ABC’s high-volume sell- off — accused of targeting a stock prone to excess declines should . prices punch through a margin lender’s nominated “maximum " security” hurdle. Forced sales of FEM!“ i collateral stock would-then push prices lower, creating a profitable exit point. for short sellers. Givengthat this shorting is taking place outside the ASK-supervised short-selling market, this criticism of hedge funds needs to be placed in context. . First. while it is highly likely that ' hedge funds have participated in this process, they are certainly not alone. Proprietary trading desks of most of the large investment banks have been at least as active in this , process. . A preprietary trading desk takes positions on behalf of the bank as principal} rather than on behalf of clients in an agency capacity. _ Profits derived by such trading have been anincreasingly large part of investment banking income generation over recent years. Ironically. following the losses by investment banks as areth of the sub-prime meltdown, many are, now signalling a minding-back of this activity; UBS announced as much during the week. 7 It is worth outlining the differences between the two strands of short selling. For most retail investors it involves the selling of what the ASX ' calls “approved short sale ‘ _ products”. This market has reasonable depth and a range of rules, including a maximum shorting limit of 10 per cent of the stock and no shorting of stocks subject to takeover. Investors can access a dafly list of approved stocks on the ASX website. I But the bulk of shorting activity occurs via the far less conspicuous securities lending market. This is where hedge funds and = , ‘ proprietary trading desks source scrip to cover their short positions, While these lending transactions are recorded by the parties involved, there is no legal , requirement for reporting them. This market developed once ‘ institutions and custodians . realised that they could generate additional income on their holdings I by “lending” the stock to those ' with a desire to short sell. Shorting per se has been viewed . by market participants almost as a necessary evil because of its positive impact on liquidity. But authorities have real problems with accusations that the short sellers are regularly targeting specific price levels (in this case, the level at which a margin lender may sell stock that is held as security) through their selling. This raises I some key legal issues. Such action can potentially be deemed manipulative, in that it could be classified as selling with the sole purpose of driving down the stock price. This.is a tricky situation. ' Why else would you be shorting? The short answer is because you have an expectation that "other _ factors” will create a price decline. For those trading ASK-approved short sales, there is built-in protection against this offence through what is known as the - uptick rule. This means that a seller cannot place an order to sell at aprice that is lower than the last trade. Under such an arrangement ' ,. it is difficult to argue that a short ngtreflds can be (long on misery _ seller is forcing a price lower. But the uptick rule does not apply to short selling taking place via the stock-lending market. Accordingly short sellers, such as the proprietary trading desks of investment banks or the hedge ' funds; are operating against the threat of a review of their activity by the Australian Securities and investments Commission. ' To date these reviews have been relatively low-key, given that ASX regulations do-not specifically focus on manipulative trading with short selling, because of the apparent protection offered by the uptick _ rule. In the US, market regulator Securities and Exchange Commission cites such activity as a specific violation. Ironically, in the US and the UK, in the past this ' same uptick rule has been deemed sound protection in their short- selling guidelines. But this has recently changed, with first the' US and now the UK and Canada scrapping the uptick rule. it Editorial, page 62 7r?” he —i +"-, - ‘ - March 12, 2008 ~ ' COMMENTARY ., _ he federal Minister for Superannuation and Corporate Law, Nick Sherry, has set himself a broadacre task in a minefield. His mandate across superannuation and corporate law should be daunting in today's environment, but like the rest of Team Rudd. Senator Sherry has cheerfully been ' 7 planting reviews like there is no ‘ tomorrow. While Senator Sherry is a newcomer to corporate regulation, and the government needs time to acclimatise, there are obligations to the market to . make messages clear, not confusing. The ministers whose . portfolios cover the capital 3 markets know'there is no need to panic, and this is a time to voice the mantra to investors that markets go up and down, and that a cautious, rational response to investments is needed. They must ensure any perceived The Weekend Australian Financial Review www.afr.con1 ‘ entrainment. _ «A ' Once more the danger lies in too much regulation ' regulatory gaps do not chise investor confidence. . The market itself is in re ason- able shape, despite a bearish run for several months as global growth slows and some optimistic parameters become unstuck. Yes, there are losers from the recent 'rout affecting a small number of companies. Investors who dived ' in on the basis of scant under-‘ standing and a' good vibe have little reason to whine. That said, the market isn’t perfect. The practice of stock lending has been swept into retail consciousness, but like hedge fund I “raids” the-issue is overdone. Absent evidence of collusion, it seems short sellers have picked out vulnerabilities that would prObably_ have emerged anyWay. And some directors of the’pas't week's, bunny, ABC Learning Centres,he;avily . geared and close-to margin calls on big share loans, fitted the bill. The market regulators on Friday decided it was time to reach deeper into the boardroom and explicitly require disclosure of margin loans and terms on material stakes of company - shares. Banking covenants and default triggers may also get exposed under the new guidance. But if the impact of “evolving community expectations” is to dissuade directors from owning 'shares in the companies they supervise, it is a poor outcome, _ Investments Commission — about marketdisclosure. Despite privacy concerns, the latest . response is justified in making the market more transparent, but is a concession the regulators were Caught napping on the issue. Still, it’s bettor‘thau a kneejerk reaction like new legislation. Senator Sherry recently announced other reviews that affect investors. some more lfthe impact is_ to dissuade directors from oWning shares in the companies they supervise, it is a poor outcome. - and will discourage active risk taking. All directors will now be more cautious about their loan' exposures. Who wants to be a sitting duck for. short sellers? 7 The AFR disclosed earlier in the week discussions between gtwernment and the regulators - Australian Securities Exchange ‘ and Australian Securities and . incendiary than others. Greater transparency and accountability in executive remuneration could be code for binding shareholder votes ' — an unwarranted intervention. And any move to “strengthen - ' disclosure regarding corporate sustainability reporting without .' imposing regulatOry burdens on business” sounds oxymoronic. ._ ..-____ .mum-i....r.Midsummmunrawrgaumsna cammamum.“are.“Hugues“as.an.L.......-..;m..-W.-“.-a..._-¢.iAmendment“ m. On Friday, Senator Sherry met with his working group on simpli- fying product disclosure state— ments. The aim is to overcome unwieldy and unreadable docu- ments and encourage companies to use plain English, enable com- parisons across asset classes and keep it short, under 10 pages. Their first outing is expected to be new 10w-doc banking products for home owners. Product disclosure in super- annuation will get a'thorough going over, with governance and marketing of self-managed super funds targeted for reform. The last thing business needs is mixed messages from government = about financial markets. Directors are .already under substantial personalrliability from state and federal laws, and a High Court decisionin Sons of Gwalia has exacerbated the difficulties. .What the business community needs is a fair hearing of the consequences of any reforms. ...
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This note was uploaded on 08/13/2010 for the course FINS 2624 R taught by Professor Yippie during the Three '10 term at University of New South Wales.

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Mumford_ AFR_20080301_Local short selling trends can be long on misery

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