A new version of the Securities and Futures Commission ("SFC") Guidance Note for short selling reporting and stock lending record keeping requirements (the "Guidance Note") was issued on 28 November 2002. This consolidates and replaces an earlier version of the Guidance Note and the addendum thereto, dated August 2000 and June 2002 respectively.

The revised version of the Guidance Note consolidates the earlier publications on the same subject and sets out requirements relating to the creation of an audit trail by securities intermediaries for the short selling and stock lending activities they have carried out.

In addition, the revised Guidance Note takes into account the recently enacted Securities (Miscellaneous)(Amendment) Rules which, among other things, introduced new exemptions to the prohibition against uncovered (or "naked") short selling of securities under ss.80 and 80B of the Securities Ordinance.

Naked short sales – exemptions

Section 80(1) of the Securities Ordinance generally prohibits "naked" short selling of securities (i.e. a sale of securities where the seller does not have an unconditional right to vest the securities in the purchaser) through the Stock Exchange.

Before the rule change, Rule 17 of the Securities (Miscellaneous) Rules specified certain exemptions from s.80(1). These included sales of specific instruments by market makers appointed by the Hong Kong Monetary Authority ("HKMA"), sales of shares of Stock Exchange-traded funds by their market makers and sales of underlying securities of stock futures and stock options contracts by market makers for hedging purposes. The revised version of the rules came into effect on 15 November 2002.

Under the new rules, the exemptions have been expanded to facilitate registered market makers or liquidity providers when performing market making obligations or hedging market making positions. As a result, the following persons are now permitted to conduct "naked" short sales:

  • short selling of certain specified instruments by HKMA-appointed market makers and their agents
  • short selling of securities or futures by recognised securities or futures market makers conducting "jobbing business" (defined to include certain hedging functions performed in prescribed contexts)

Covered short sales – reporting requirements

Under ss.80A-C of the Securities Ordinance, "covered" short sales are permitted provided that the seller confirms at the time of placing the sell order that it is a short selling order and that it is covered. Certain reporting requirements apply under ss.80A-C and Rule 18 of the Securities (Miscellaneous) Rules specifies alternative modes of compliance. The new Guidance Note reiterates these alternative modes of compliance by stating that a person may be exempted from the full reporting requirements, broadly, in the following circumstances:

(a) sellers who provide or receive an oral (as opposed to documentary) assurance when they place or accept a short selling order will be exempted from the reporting requirements if certain prescribed details are recorded on a time-stamped document that is kept for at least 12 months;

(b) sellers who obtain tape-recordings (which must be kept for at least 12 months) of an assurance, made orally at the time the short sale order is placed, of prescribed matters will be exempted; and

(c) sellers who obtain or convey an oral assurance, at the time of the short selling order, of prescribed matters and by the end of the trading day provides or receives documentary confirmation (which must be kept for at least 12 months) of the matters will be exempted.

© Herbert Smith 2003

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