The Financial Services Authority (the main UK financial regulator and supervisor) announced on Friday 13 June 2008, that as of Friday 20 June 2008, short-sellers will have to disclose short positions in stocks undergoing rights issues, if these short positions amount to more than 0.25 per cent of the total shares outstanding. This new disclosure requirement for short sellers is much more stringent than the 3 per cent disclosure level that applies to long positions.
The FSA justifies this measure on the grounds that under current market conditions (post-August 9, 2007) short selling can be especially disruptive and damaging:“In current market conditions, there is increased potential for market abuse through short selling during rights issues. As a result, there has been severe volatility in the shares of companies conducting rights issues. This is potentially damaging not only to the issuers in question but also to confidence in the overall fairness and quality of the UK market. It can be particularly prejudicial to the interests of small investors. The problem is compounded by the length of time taken to complete rights issues.”
Quite so. But this leaves a number of questions unanswered.
- Throughout the financial market turmoil of these past 10 months, equity markets have remained liquid. Stock markets (that is, the secondary markets for trading already issued stocks) are certainly more volatile than they have been during the 3 or 4 years prior to the outbreak of the financial crisis, but they remain ‘orderly’ in the technical sense, that prices clear markets without any obvious evidence of non-price rationing of buyers or sellers. New issues markets indeed tend to be less liquid than secondary markets, but is is not clear that this would make short sales any more damaging than speculation in the opposite direction, that is, speculation through long positions in stocks. Are market manipulation and other forms of market abuse by larger players (and/or by collusion among players) more likely and more damaging if they take the form of short sales rather than of long positions?
- Is speculation that causes stocks to be underpriced inherently more damaging than speculation causing stocks to be overpriced? Is this true only for stocks undergoing rights issues? Is this true only for stocks undergoing rights issues during periods of financial market turmoil or crisis? What can be said about the relative dangers associated with undisclosed long and short positions when there is financial market euphoria and when stock markets are booming?
(a) Why don’t we have the same disclosure requirements for short sales and long positions during rights issues?
(b) Why don’t we have the same disclosure requirements for short sales and long positions during periods when there are no rights issues?
(c) Are we going to see disclosure thresholds of 3% for short sales and of 0.25% for long positions when there are rights issues and financial markets are booming?
- If rights issues take too long to complete, ought not the FSA to do something about that directly, rather than mucking about asymmetrically with short selling rules?
The only argument for having disclosure requirements for short sales different from those for long positions in stocks is that stocks (ownership claims to the residual income of listed companies & associated residual control rights) are in positive net supply (if we lift the corporate veil). So there is a natural, net long position, equal to the total stock of equity outstanding. Whether that rather trivial point translates seamlessly into a 0.25% disclosure threshold for short sales during rights issues and a 3% disclosure threshold for long positions is doubtful.
I can understand why, following the Northern Rock debacle, the FSA want to be, and wants to be seen to be, alert, on the ball and decisive. They ought to recognise, however, that it is possible to be alert, on the ball, decisive and wrong.
A whiff of pandering to the populist thirst for speculators’ blood hangs over this measure. Short sellers in a falling market are second only in popular market demonology to price-gouging grain-hoarding ethnically distinct middlemen during a period of rapidly rising grain prices.
Speculation, including short selling, is a necessary instrument for achieving efficiency in a dynamic market economy. It’s not sufficient, of course. Market manipulation and abuse can lead to severely distorted and inequitable outcomes. It’s just not clear to me how, by favouring one form of speculation over another, this measure by the FSA makes such distorted and inequitable outcomes less likely.