On Sunday 21 September ASIC took further emergency action in response to bans on short selling of stocks imposed by regulators in other global financial centres. This has had immediate consequences for hedge funds, with Standard & Poor's Funds Services putting 57 funds 'on hold' today. The consequences for market liquidity and efficient price determination and the ability of many traditional long investors to hedge their risks will be significant.
These steps were taken, in ASIC's words, "to maintain fair and orderly markets in these exceptional times of global crises of confidence in financial markets"1.
Whether the regulation will ultimately have the desired effect is the subject of considerable debate. The hedge fund industry has, for example, responded to equivalent restrictions imposed in the UK with the statement that, the ban will merely "allow a false market to persist with an overvalued stock price"2.
Temporary Short Selling Ban - effective from Monday 22 September 2008
In any event, ASIC made the following decisions to apply from the opening of the market on Monday, 22 September 2008 until the End Date (being the date when the government implements short selling legislation)3:
- Contrary to ASIC's announcement on Friday 19 September, covered short sales for all listed stocks4 will now not be permitted (subject to a limited authorised market-maker exception)
- ASIC will reassess and advise the market in 30 days, whether or not it will at that time, or at a later date, reopen covered short sales for non-financial stocks.
"Covered" short sales are sales where the seller enters into the sale on the basis that it will be able to settle the trade using stock which a third party has agreed to lend to it under a securities lending arrangement.
See ASIC's Sunday 21 September media release and Instrument .
Market-making exceptions - consequences
The ban does not extend to short sales by financial institutions for the purposes of hedging positions entered into as part of their "market making activities". These activities are limited to activities as market makers of ASX-listed derivatives and warrants.
In other words, issuers will be prohibited from short-selling in order to hedge their exposures in relation to the issue of over-the-counter derivatives - meaning that the availability of such derivatives will be severely curtailed.
What about current OTC positions? - ASIC "no action letter"
One obvious problem created by the issue of the new rules in such urgent circumstances was that they left issuers of over-the-counter derivatives in the position where they were prohibited from using short sales to hedge existing exposures.
During the course of today, Monday 22 September, ASIC endeavoured to plug this gap by announcing that it will provide a "no action letter" for, "hedging of existing positions of market makers arising from their client business... to the effect that the prohibitions on covered short sales 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 (whether OTC or exchange-traded) to fulfil orders received from clients or to respond to a client's request to trade, in each case before that date."
See ASIC's Monday 22 September media release .
The uncertainty surrounding the announcement released on Sunday evening caused the ASX to delay the opening of trading for an hour, until after ASIC issued this release.
What about extant covered short sales?
Given that the short-selling prohibition applies to the act of "selling" (which is generally interpreted to mean the entry into the trade, as opposed to its settlement) trades entered into prior to 22 September 2008 which were covered short sales should be unaffected and able to be settled in the manner originally anticipated.
While this interpretation is not completely beyond doubt, it appears to be the only workable interpretation of the announced changes.
Earlier announcement of bans on naked short sales and disclosures of short positions
The actions of ASIC on Sunday 22 September superseded the measures it had announced earlier on Friday 19 September, being (relevantly):
- to ban or not permit naked short selling
- to introduce a reporting regime for permitted covered short sales.
See ASIC's Friday 19 September 2008 media release .
Naked short selling (as opposed to covered short selling) is, generally, the practice of selling shares without a confirmed arrangement with a third party to lend the securities to cover settlement of the trade.
While it remains to be seen when and how the ban on covered short sales referred to above will be lifted - when it is, these two measures will obviously attract greater attention.
Briefly, ASX's "approved list" of stocks which were able to be short sold to a limited degree without being covered, is abolished.
Further, ASIC clarified that it would consider the following practices to be illegal naked short selling: selling stock during the course of the day with the intention of buying the stock to cover the sale prior to the end of the trading day; and selling stock with only a "best endeavours" promise (as opposed to a legally binding commitment) from a third party to lend the seller the stock to cover the sale.
Finally, in the case of covered short sales (currently banned altogether) ASIC announced that a client would be obliged to inform the broker that a transaction is a covered short sale of this type and the broker then must inform the ASX. ASX will then report each morning on short sales that are reported to it for the previous day, consistent with its present reporting of naked short sales.
What about the "market manipulators"?
The bans on short selling announced globally could be seen as a recognition by regulators that they have no other means of effectively preventing perceived widespread market manipulation - undertaken via the combined use of false rumours and directional short selling in a nervous market.
It would therefore not be surprising if, during the period of the current bans, governments overseas and in Australia took steps to address that perception by changing the law to make the identification and/or prosecution of such activities easier.
What next?
ASIC has said that the ban on covered short selling will operate for a limited time and in the case of non-financial stocks, will be reviewed in 30 days. In the case of financial stocks, it has said that the review will be in line with the time limits imposed by other international regulators such as the US and UK.
We also note that these amendments have been made by ASIC Class Order, pending the government making legislative changes in relation to short selling (which have been anticipated for some time). Until now it had been anticipated that these legislative changes would only relate to the disclosure of short positions. It remains to be seen whether recent events will influence the legislative changes that are proposed to be made.
Footnotes
- Mr Tony D'Alosio, ASIC 08 205 "Covered short selling not permitted", 21 September 2008.
- AIMA, Press Release, "Hedge fund industry calls for measured approach in dealing with financial market volatility", 18 September 2008.
- The Government is expected to introduce a "Short Selling" Bill into parliament in the current sitting.
- This is in contrast to the bans in theUS and UK which were limited to financial stocks. ASIC extended the bans in Australia to all stocks on the basis that, in its view, given the small size and the structure of the Australian market "the risk of unwarranted activity on the Australian market was intensified".
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