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‘Shorting’ in SA

Why there’s no GameStop-type drama here.
It’s difficult to know whether the lack of disclosure on the JSE contributes to the limited shorting activity on the market. Image: Shutterstock

As the dust settles and the GameStop share price plummets back towards earth it becomes evident there’s little chance of similar drama playing out in the South African market now or any time soon.

Not that there isn’t a large number of potential retail investors who wouldn’t like to ‘stick it’ to powerful institutional investors. But the fact is that although South Africa is ahead of many emerging markets when it comes to short-selling, the local market is not active or robust enough to support the type of frenzied trading that saw GameStop’s share price rocket from around $40 to just below $400 in less than a week.

And, crucially, there is almost no disclosure relating to the current limited level of short selling activity in South Africa. Frustratingly, judging by the response from the JSE and the Financial Sector Conduct Authority (FSCA), there is little hope of any improvement on this score in the short to medium term.

Read: ‘Game over’ for hedge fund

A related factor is that in general there’s limited retail investor activity in the local market.

Jean Pierre Verster, CEO of Protea Capital Management and one of the best-known, and most effective, short-sellers in the local market, reckons that at any time probably little more than 3-4% of the local market is short. Even if this is concentrated on 20 or so favourite stocks it means there is way too little activity to support the sort of dealing patterns that underpinned GameStop’s rise to global fame at the end of January.

“The hedge fund industry is South Africa is worth around R65 billion out of a total market of over R2 trillion, about 50% of that R65 billion would be short at any time,” explains Verster.

Hedging by shorting

He says investment banks providing loans to corporate executives secured by their shares would also account for a large chunk of short activity. The banks would hedge their loans by shorting the share. But even if this is added in, the level of short trading remains a small percentage of the total.

An additional factor inhibiting any kind of aggressive action similar to the GameStop drama is the lack of information around short positions on the JSE.

In the US the army of retail investors involved in trading in GameStop shares benefitted from knowing how many of the company’s shares had been shorted. In general, if this is a large percentage then it makes the sort of squeeze created by the buying activity of the retail investors much more effective. But if you have little idea of what the extent of the short position is, a GameStop-type play would be high-risk.

Read: Michael Burry cashes in on GameStop

It’s difficult to know whether the non-existent level of disclosure on the JSE contributes to the limited shorting activity on the market or whether the poor level of disclosure is caused by the limited shorting activity. But the reality is there seems no rush to improve on disclosure with neither the JSE nor the FSCA planning to implement any sort of action in the near term.

‘Possible’ regulatory responses …

Occasionally the issue does bubble to the regulatory surface; recall back in September 2018 when the JSE issued a consultation paper with the catchy title ‘On possible regulatory responses to recent events surrounding listed issuers and trading in their shares’?

There were no fingers pointed directly at Steinhoff, Tongaat or Iqbal Surve’s Sagarmatha but most knew who was behind the ‘recent events’.

“The South African financial markets have, over the past year, been shaken by a range of corporate scandals, rumours and innuendo,” explained the JSE in the introduction to its 2018 consultation paper.

Read: Shining a light on short selling

These unsettling events led to questions about how certain alleged activities were able to happen and, said the document: “Whether regulators such as the JSE could have taken action to prevent certain activities and whether those events have highlighted any regulatory provisions that might need to change.”

There was a passing reference to concerns about the impact of short selling, which had contributed to the dramatic slump in the Steinhoff share price.

Disclosure

While the JSE noted that short selling is a legitimate form of market activity and plays an important role in the price formation process, it questioned whether some level of disclosure of short sale positions might be appropriate. “Information on short positions enable investors to make better risk assessments when investing and allows regulators to perform their market surveillance and market abuse investigations function more effectively,” said the JSE.

It referred to the FSCA’s decision to implement a short sale disclosure regime: “Whereby information on short sales of listed securities is provided to the investing public and the regulators.” The JSE said it was strongly supportive of this initiative.

This week the JSE confirmed to Moneyweb that it does not have the regulatory power to enforce the appropriate disclosure.

“Short positions would need to be disclosed by the investors who hold those positions. The JSE only has regulatory jurisdiction over its member firms so it is unable to impose a regulatory requirement on investors,” said Shaun Davies, director of market regulation at the JSE.

What’s on the cards

Two months after the release of the JSE’s September 2018 consultation document, the FSCA released a discussion paper on the implementation of a short sale reporting and disclosure framework. On the cards appear to be measures that would bring SA into line with leading international markets including the flagging of trades as shorts where appropriate. This would allow the JSE to publish aggregate short-interest data for each listed company.

Currently JSE trades are only flagged as a buy or a sell.

In addition, the FSCA paper alludes to the requirement in some markets that individual parties with a short position equivalent to 1% or more of the outstanding equity in a company disclose that position. This is similar to, although puzzlingly more onerous than, the obligation by investors with a 5% long position to disclose that.

More consultation …

Asked for an update on the 2018 discussion paper Jurgen Boyd, divisional executive, market integrity at the FSCA told Moneyweb this week: “The FSCA has considered the extensive comments received and is currently preparing, for publication, a position paper in response thereto, following which a conduct standard will be drafted and published as part of the consultation process.” So, no rush there.

Currently traders with access to the large brokers who do the scrip lending required by short sellers (uncovered short sales are prohibited in South Africa and most markets) can get some indication of the short position in individual shares, and Bloomberg compiles statistics, but these are at best no more than indicative.

Verster welcomes the prospect of better aggregate short-interest disclosure, which he believes will assist most market participants and reduce the risk.

Meanwhile, the JSE could use the limited power at its disposal to ensure better disclosure of derivative trading due to executives who use their shares as security for bank loans.

All in all, there’s very little chance of something like the GameStop drama playing out on the local stage for the foreseeable future.

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COMMENTS   13

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And yet the JSEs stock look very frothy on the whole.

Every time I hear the “it’s not going to happen” slogan I prepare myself for the worst on what is going to happen.

What happened to the famous short seller ViceRoy (2 guys with computers working from home) who caused such mayhem with Capitec in 2018? The share price is not far from an all time high. I am still waiting for the whole bank to fall apart.

I don’t think it has to fall apart; just reach whatever the shorted target price was, cash out and bank the money.

They made themselves and their hedgy clients lifechanging money shorting German firm Wirecard. They are in the big leagues now. SA mickey mouse companies are not even on the radar of hegde fund shorters anymore purely due to size and liquidity.

those structures whereby executives raise funds using their company shares should be deemed trading in shares and require disclosure on SENS. Shareholders should be very concerned if Harry Hiredhelp (1) has debts that are multiples of his salary (2) pledged shares that can be called if the price drops.

The only reason why we don’t have as much short selling in South Africa is that people who are stupid enough to short illiquid shares don’t have the money to do so here. In the USA on the other hand, due to the low interest rates, fools have money to do stupid things. Shorting illiquid stocks in the strongest bull market in history is like picking up pennies in front of a steam roller.

The demise of the hedge funds that were caught in the short squeeze is part of the normal behaviour of the market that separates fools from their money. The money lost by the short hedge funds was transferred to long positions. It is a zero-sum exercise.

We also didn’t get $1200 from the Fed because we were stuck at home in lockdown, like the millennials who got bored playing video games and decided to try some real action with free money.

I have worked with Quantitative traders some 15 years ago. They made massive mark – to -market ”paper profits” . Methinks these traders, hedge funds and private equity funds think they reinvigorated trading and that their operations appear to represent the finance and trading of the future.

Quantitative trading is a strategy that uses mathematical functions to automate trading models, which most of these types of traders use, at the very same time.

In this type of trading, back-tested data are applied to various trading scenarios to spot opportunities for profit. When they start positioning themselves, they all collectively push the same stocks down and the contra trades higher.

Information systems that supply unprecedented detail of the state of the stock markets support the ability of financial institutions (stock brokers, hedge funds, banks etc) to rapidly identify abnormal or niche profit opportunities – that is, those whose risk adjusted rates/prices are above normal.

Most of those Quant traders end up losing lots of money , as all of them jump on the bandwagon when and if their models start giving “take profit” signals. They again close their positions and push the market against each other.

Abnormal (short-long) returns in an essentially unregulated market always reflects the inefficiencies in the flow of these types of strategies.

As a consequence these types of markets during the latest financial market crisis became surfeited, like in 2006. Lots of these funds will be forced into liquidation due to the fact that they tried to harvest the niche profits , when they saw their counterparts/competition pick with outstanding success in vanilla markets.

Unfortunately, the easy money was usually made by conservative ”run of the mill” strategies and many of these eager would be hedge -fund ”traders” saw their large new net worth (paper -profits) disappear!

Pension fund managers and novice traders believe in this fallacy that the application of advanced mathematics must deliver superior returns. They pour money into mathematical models and fancy formulas while the market is actually driven by the irrationality of emotions – fear and greed.

The one on the other side of the trade is a human with his personal emotions and perceptions, although that human may be represented by a mathematical model. People tend to admire and trust stuff that they do not understand. The more opaque and confusing the strategy, the bigger the motivation for the investor to pour money into it.

In 1997, Scholes – together with Robert C. Merton – was awarded the Nobel Memorial Prize in Economic Sciences for a method to determine the value of derivatives. These two gentlemen designed the mathematical models that were used by Longterm Capital Management to do low-risk arbitrage for pension funds. To cut a long story short, the bankruptcy of the hedge fund almost took down the entire financial system in 1998. Their quantitative model was eventually bailed out by the average US taxpayer who cannot even use a calculator.

“Simplicity is the ultimate sophistication” – Albert Einstein.

Absolutely – In my Corporate Treasury – I specialized in and sold Currency Derivative to the Mining Sector !

The LTCM was is ”a pointe”, a high-visibility, high prestige operation that changed into a train wreck, yes.

The explosion of the largest Wall Street hedge fund manager with investments of US 4 125 billion for its very rich clients (including Myron Scholes & Robert Merton).

They specialized in risky, lucrative deals in US, Japan, and European Bonds., leveraging their bets with more than US$ 120 billion borrowed from Banks! It also carried some US$ 1.25 trillion in financial derivatives , exotic contracts (something that I point blank refused to sell to ”anybody” in my dealing life!), that were only partly reflected on its balance sheet.

Some of these were speculative investments , and some were engineered to hedge, or insure, LTCM’s portfolio against every imaginable risk.

Nobody never knew for sure how highly leveraged LTCM when things started going wrong. I think the best estimates were that they had invested well over US$ 35 for every US$1 it actually owned!

According to some material I read somewhere they were geared round 40 times when times were good. When the gearing hit the fan and the clients began to withdraw capital the gearing rose to 450 times. They used the risk-free positions as collateral for loans. The value of the collateral blew up and sucked the liquidity out of the international financial system.

A f-up of epic proportions. It proves that you need at least a doctorate in mathematical science if you plan to destroy the financial system.

Should Read US $ 125 billion ……

End of comments.

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