17th June 2008

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APCIMS welcomes announcement by FSA and the Chancellor to ensure transparency in short selling

In response to the FSA’s statement last week and trailing the Chancellor’s announcement on short positions in the forth coming Mansion House Speech, David Bennett CEO of APCIMS said:

“APCIMS welcomes an attempt by the Government and FSA to improve transparency and put all investors on an equal footing.

“We have urged the FSA not to restrict short selling in the UK but are calling on them to ensure better information and full transparency in order to improve shareholder confidence.

“APCIMS have consistently called for investors to declare where they are going short in over 3% of a company’s total stock. Going long in 3% or over of the total stock in a company must be disclosed to the market. A parallel regime should apply when going short.

“It is apparent that the FSA have had to act quickly on this occasion and we welcome their swift response to protect investors. We are glad to hear that a whole range of matters including the issues of transparency around various issues are going to be consulted upon for the benefit of the whole investment community. We look forward to being part of the debate. ”

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Notes to editors:

Short Selling

Short selling is the sale of a security that the seller does not own. A “covered” short sale is made by borrowing securities to ensure delivery; a “naked” short sale is made without any borrowing. Settlement disruption can arise if securities for delivery are not available.

Current issue

In the first quarter of 2008 the share prices of financial institutions were highly volatile. Some evidence has suggested that aggressive short selling was used to drive down individual share prices artificially with a view to profiteering on the outcome. If so this could amount to market manipulation. The FSA together with regulators in other countries is currently investigating the situation.

Pros and Cons

Defenders of short selling see it as a necessary, indeed desirable, feature of the market that plays an important role both in providing liquidity and accelerating price corrections in over-valued stocks. Some believe that short sellers tend to stabilise prices in a declining market by covering their short sale positions often opened at the start of a downturn.

Critics of the practice view it as increasing share price volatility, exaggerating share price declines and forcing the price of individual stocks down to levels which might not otherwise be reached. It is argued that, in extreme cases, it may depress the price of a security so much that it could create problems for the company in question by undermining commercial confidence and/or by making fundraising more difficult.

Regulation

UK: Short selling is regulated in different ways in different jurisdictions. In the UK there are no particular restrictions but short selling must take place within the legislative and regulatory framework set by the Financial Services and Markets Act 2000 and the FSA’s principles and rules. This includes the market abuse régime which is designed inter alia to deal with manipulative practices.

New transparency requirements were introduced following the full FSA review of short selling in the bear markets of 2002/03 but these did not involve changes to FSA rules. Instead, the UK securities settlement system, CRESTCo (now part of Euroclear), agreed to publish aggregate stock lending data for FTSE 350 securities on a monthly basis as a helpful proxy for information on short selling. And CRESTCo and the equity exchanges set out proposals to inform the market of delays to or failures in the settlement of some securities, often brought about by naked short selling. It was argued at the time that these measures would improve the information available to the market in relation to short selling and be of benefit to consumers.

The FSA decided against stronger rule-based changes such as the then US-style price ‘tick’ régime (see below), banning short selling in certain types of stock, or introducing a marking and reporting régime for short sales in the cash equity market. In their view the benefits of such initiatives would not justify the costs. They were also concerned that imposing these requirements might detract from market efficiency by depriving the market of some of the benefits of short selling, such as the acceleration of price corrections in overvalued securities.

USA: In the USA short selling has historically been subject to greater constraints. The well-known ‘tick’ test (rule 10a-1), having survived since the 1930s, was abolished with effect from July 2007. Under it short sales were only allowed when the last sale price was higher than the previous price. The rule has been replaced by the provision that no price test shall be imposed on short sales in any security.

Other key US regulations remain in place:

Regulation SHO regulates short sales and:

defines both ‘short sale’ and the ownership of securities (including those underlying securities futures contracts),
specifies the securities borrowing and securities delivery régime (it has the deliberate effect of limiting naked short sales), and
sets out the requirement for broker dealers to mark all equity sell orders as “long” or “short”.

Rule 105 of Regulation M prohibits the purchase of shares in a public offering by brokers who have previously shorted those shares, thus limiting the possibility for manipulating the price of such offerings.
Regulation T of the Federal Reserve Board requires all short sale accounts to have 150% of the value of the short sale at the time the sale is initiated. The 150% consists of the full value of the short sale proceeds (100%), plus an additional margin requirement of 50% of the value of the short sale. This improves the likelihood that the borrowed shares will be returned.

APCIMS: APCIMS responded to the FSA 2002/03 review consultation. It urged the FSA to adhere to its existing positions and to resist calls for restrictions on short selling in the UK. But it also said that more information and better price transparency would benefit users and improve market confidence.

Shorting disclosure: In line with this approach APCIMS believes that going short in over 3% of total stock in a company should be declared in the same way as required when accumulating over 3% long. This would allow investors to see which stocks are being substantially shorted and would have some correlation with the US requirement to mark equity sell orders.

CFDs (contracts for differences): We also favour greater transparency in trading in contracts for differences (CFDs). This is increasingly popular. A CFD is an agreement between two parties to exchange the difference in value of a particular share between when the contract opens and when it closes. A position can be opened on margin, which is much cheaper than cash dealing, while the CFD does not confer share ownership so the final transaction at contract close is not subject to stamp duty. This option is obviously attractive yet trading in CFDs is not subject to the same reporting requirements as cash equity trading. A means of achieving greater transparency in this area needs to be found without detriment to the benefits of the CFD market.

Other: other jurisdictions vary. A comparative study by IOSCO in 2003 found that the main continental European markets applied no restriction on short selling but that in varying degrees other major markets including the USA, Canada, Australia, Hong Kong and Japan did. It is not known what developments there have been since that time (apart from in the USA).

APCIMS
APCIMS is the trade association of more than 220 firms who, on more than 400 sites across the UK and Ireland, deal in stocks and shares for private investors. Together our aim is to ensure that the regulatory, tax and other changes across Europe bring real benefits to the investment community.

More than 12 million people in the UK currently invest directly in stocks and shares to secure their financial futures.

As of 1st December 2001 all UK APCIMS members have been regulated by the Financial Services Authority (FSA). The FSA succeeds IMRO (the Investment Managers Regulatory Organisation) and the SFA (Securities and Futures Authority) as the regulatory body for private client stockbroking and investment management.

For further information please call:

Dirk Paterson, Head of Communications, APCIMS
on 020 7247 7080
Mobile: 07507 855 428
Email: dirkp@apcims.co.uk

David Bennett, Chief Executive, APCIMS
on 020 7247 7080
Mobile: 077689 50041
Email: davidb@apcims.co.uk