‘Shorting’ clampdown welcomed by managers and brokers

The new raft of disclosure rules that require hedge funds and other short sellers to reveal the “significant” short positions they take in the shares of companies carrying out rights issues come into force on Monday – but the requirements have yet to have much of an effect on the market.

On the last trading day before the Financial Services Authority’s rules are introduced, shares in the bank HBOS, which is looking to raise £4bn by going cap in hand to investors, fell a further 4.9 per cent to 282¼p, having briefly fallen below the 275p a share price of its pending rights issue. And shares in the mortgage lender Bradford & Bingley, which is also planning a rights issue, were down as well yesterday.

The FSA’s new rules on short-selling will apply only to those who bet against shares in companies undertaking rights issues. The City’s watchdog is making investors disclose any short positions representing over 0.25 per cent of issued shares.

Even so, analysts claim the clampdown is likely to encourage transparency in the wider shorting market – a move they favour.

David Bennett, chief executive of the Association of Private Client Managers and Stockbrokers (Apcims), says: “There’s a real feeling that greater transparency in the market when people are going short would benefit
the overall health of the
market.”

Apcims is therefore calling for regulators to require investors to declare when they are shorting more than three per cent of a company’s stock, in any circumstances.

“Going long in three per cent or over of the total stock in a company must be disclosed to the market, so a parallel regime should apply when going short,” said Bennett.

The practice of selling shares short in expectation of a price fall is becoming more common amid the
market downturn. Long the domain of hedge fund managers skilled in arbitrage, in recent years, shorting has become more accessible to small-time investors.

The rise of 130/30 funds, which go 30 per cent short and 130 per cent long and are offered by well-known fund management houses, underscores its growing acceptability as does the increasing use of the flexibility allowed under Ucits III regulations which has seen more managers making use of it.

Also, as the volatility in the market remains, more private investors are looking to spread betting and contracts for difference as a way of shorting (see box below).

And in yet another sign of its popularity, this week Deutsche Bank launched what it describes as the first exchange traded fund to track a short position on the FTSE 100. Yearly fees are low at just 0.5 per cent.

“With the current market turbulence, investors will now be able to take a short position against the FTSE 100, enabling them to take advantage of any downturns in the UK stock market,” says Manooj Mistry, head of exchange-traded tracking funds at Deutsche Bank. “In the past, only professional investors have had the tools to be able to go short, but our new FTSE 100 short ETF is available to retail investors, offering them the opportunity to short the FTSE 100 for low cost and at any size of investment.”

The acceleration in interest worries more cynical analysts who argue that shorting is a far more difficult skill than going long on a stock.

While its defenders laud the practice for improving liquidity and accelerating price corrections in stocks, critics claim it exaggerates volatility and forces down share prices.

A recent study released by Inalytics, a firm which evaluates fund managers, suggests that managers are less adept at selling short than they are at picking winners. The research indicates their selling decisions tend to be poor and result in the loss of about 94 basis points per year, while buying decisions add about 47 basis points per year. And the poor performance of 130/30 funds in the last year, is another indicator of the truth to this argument, analysts claim.

“Good sellers are a rare breed and tend not to fit in with the identikit fund manager. They tend to be cynical, pessimistic and always looking for the hidden problem lurking behind the next corner,” according to analysts from Inalytics.

The rules will also affect spread betters and those trading contracts for difference related to rights issues – with small investors who are wagering as little as £12,500 now being forced to publish their names under the rules.

So the requirements are not being welcomed by some advisers who are concerned that increased oversight by regulators may make the spread betting market less competitive.

“The danger with over regulation is that London will hand the overall initiative to other international bourses,” argues David Buik, spokesman for the firm Cantor Index. “0.25 per cent disclosure, in my humble opinion, will not kill off or curtail CFD or spread betting short selling in London. And I agree that skulduggery should be stamped out. But investors must be given the opportunity of expressing their opinions on specific companies or stocks.”

However, more optimistic spread betters say the overhaul is unlikely to send shock waves through the sector: “The feeling is it’s not going to have a massive impact,” says David Jones, chief market strategist at IG Index. “It doesn’t change anything. It just means that if your position is above a certain amount, you’ll have to declare it.”

Under the new regime, short sellers have to report net short positions that meet the new requirements during outstanding rights issues, and will face that obligation for future capital raisings. But they will only have to do so only once, regardless of whether their position changes. So, overall, Darren Fox, partner at Simmons & Simmons, the UK law firm, believes that the FSA move will not severely curtail the practice of short-selling.