What this means for you
- Both naked short selling and covered short selling (except for a limited market maker exception) are banned for the time being. ASIC will reassess this position in 30 days time.
- It appears that brokers could be liable for short selling by their clients, whether they know that the trade is a short sale or not. This is most likely an error in the drafting of the relevant Class Order but we are not aware of any amendments to the Class Order at this stage.
- In any event, brokers should seek confirmation (preferably written) from their clients before each sale that their client is the owner of the shares being sold and that their ownership is not as a result of a securities lending arrangement.
What has happened to date?
- On Friday of last week, ASX announced that it would remove all products from the ASX Approved Product List for naked short sales having the practical effect of requiring short sales to be covered.
- On the same day, ASIC issued Class Order 08/751 imposing reporting obligations in relation to covered short selling.
- On Sunday, ASIC issued a Class Order 08/752 prohibiting covered short selling (except for a limited market makers exception).
- Today, ASIC issued Release AD08-20 stating that it will provide a no action letter for hedging of existing positions of market makers arising from client business.
Why has this happened?
ASIC has taken the action to ban short selling in reaction to fears that hedge funds would move their short selling activities to Australia in response to bans or restrictions on short selling in overseas jurisdictions.
What does this all mean?
Prior to ASIC's actions in the last few days, the legal position, in basic terms, was that naked short selling was prohibited except in relation to certain shares approved by ASX but covered short selling was legal.
That is, section 1020B(2) of the Corporations Act provided that a person must only sell a section 1020B product (which includes securities and managed investment products) if at the time of the sale the person has a "presently exercisable and unconditional right to vest the products in the buyer". Section 1020B(4)(e) then provided that the short selling restriction does not apply to products which are included in a class of products in relation to which there is in force a declaration permitting short selling. In essence, this permitted naked short sales in relation to products included on the ASX Approved Product List and covered short selling.
Friday, 19 September 2008
On Friday 19 September, 2008, ASIC announced in Release 08-204 that all products would be removed from the ASX Approved Product List. That is, naked short selling was effectively prohibited.
On Friday 19 September, 2008, ASIC also issued Regulatory Guide 196 clarifying the meaning of having "a presently exercisable and unconditional right to vest the products in the buyer". In that Regulatory Guide, ASIC states that a person who holds legal title to the product at the time of the sale, would have a "presently exercisable and unconditional right to vest". The Regulatory Guide suggests that in a case of securities lending arrangements, "a presently exercisable and unconditional right to vest" would involve the lender giving the borrower a legally binding commitment to deliver products. The Regulatory Guide states that an agreement made at the time of the sale for the lender to provide the borrower with securities on a "best endeavours basis" cannot provide a "presently exercisable and unconditional right to vest" the financial product.
In essence, Regulatory Guide 196 provides that short selling is permissible where the seller owns the product by way of a legally binding securities lending arrangement, but restricts day traders who intend to buy back the stock on ASX on the same day as the day of sale, but after the sale takes place.
On the same day, ASIC also issued Class Order 08/751 which applied to sales made on a licensed market where at the time of the sale, the Seller's "presently exercisable and unconditional right to vest the products in the buyer" results from a securities lending arrangement entered into before that time. The Class Order required the broker to inform the market operator by no later than 9:00pm on each trading day of its net covered short position as at 7:00pm on the previous trading day. The Class Order imposed an obligation on a person who requests a broker to make a sale to inform the broker if the person's ownership in the securities being sold is as a result of a securities lending arrangement. Further, the Class Order required brokers to ask their clients whether their ownership of the products being sold arises under a securities lending arrangement the client has entered into. Effectively, this meant that covered short selling would still be permitted but enhanced disclosure of short selling would be required from both sellers and brokers.
Sunday, 21 September 2008
On Sunday 21 September, 2008, ASIC issued Release 08-205 together with Class Order 08/752.
That Class Order provides that a person must not sell a security if the person's "presently exercisable and unconditional right to vest the security in the buyer" arises as a result from a securities lending arrangement. In essence, the Class Order prohibits a person from selling securities where the person's only interest in the securities arises under a securities lending arrangement. That is, covered short selling is also prohibited. At this stage, this ban appears to be temporary with ASIC indicating that it will reassess its position in 30 days.
The wording of the Class Order potentially makes brokers liable for prohibited short selling activities by their clients. Under the new provisions created by the Class Order, a person must not sell securities on behalf of another person if at the time of the sale that other person has a presently exercisable and unconditional right to vest the securities in the buyer because of a securities lending arrangement entered into before that time. Accordingly, if a broker is selling shares on behalf of a client and that client is relying on a lending arrangement to cover that sale, then arguably the broker could be breaching the new provisions, whether the broker knew about the lending arrangement or not. This application of the provisions appears to be broader than what was probably intended.
The Class Order does not apply to Market Makers and Warrants Market Makers for the purposes of managing, avoiding or limiting the financial consequences of issuing or holding a derivative in the course of the person's market making activity.
Monday, 22 September 2008
Today, ASIC issued Release AD08-20 stating that it will provide a no action letter for hedging of existing positions of market makers arising from client business. While the terms of the no action letter are currently being prepared by ASIC, the letter will be to the effect that the prohibitions on covered short sales set out in Class Order 08/752, will not apply to:
- hedging a position that was taken by an entity prior to 22 September 2008 as part of its business of dealing as principal in equities, options or derivatives to fulfil orders received from clients; or
- respond to a client's request to trade provided that the order or the request was made prior to 22 September 2008.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.