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Shining a light on short selling

Proposed regulations will make these trades more transparent.

It is almost exactly a year ago that Steinhoff imploded spectacularly. While the market was still reeling, a previously unheard of research company called Viceroy emerged with a perfectly timed report that documented many of Steinhoff’s accounting shenanigans.

In January Viceroy followed up with a report that accused banking group Capitec of predatory lending practices and misstating its defaults. After Steinhoff, investors were easily spooked and the stock fell from R1 069.30 to R800.60 instantly (it has since recovered).

Rumours were soon swirling that the reports were leaked deliberately to drive the share prices down, to the benefit of shadowy short sellers whose identities remained hidden.

The discussion on short selling gathered pace in February when an internal report written on the Resilient Property Group by hedge fund manager 36One was leaked. The report suggested that management was artificially manipulating the share prices of its group companies. While management denies the allegations, the market is not convinced and the share price is yet to recover.

In the process, short selling, which is a stock tool used by hedge fund managers to mitigate risk, got a bad rap. Short selling involves the sale of shares that the seller does not own but has borrowed from a broker. Sellers take on these transactions because they believe a stock’s price is headed downward, and that if they sell the stock today, they’ll be able to buy it back at a lower price at some point in the future.

Thus it seems timeous that last week the Financial Sector Conduct Authority (FSCA) published proposals that aim to bring more transparency and regulation into the practice of short selling for comment.

“We believe that improving the transparency of short sale transactions will have distinct benefits that will outweigh any associated costs,” the document reads.

Greater disclosure will help deter market abuse and reduce the risks of disorderly markets posed by short sales. It could also provide early warning signs of a build-up of large short positions, thus alerting regulators to potentially abusive behaviour and enabling them to monitor and take action more effectively.

An FSCA spokesperson noted though that the regulator would prefer to keep a light hand when it comes to regulation. “While some aspects of short sales require regulation, short selling has an important role to play in the market: it contributes to efficient price discovery, increased market liquidity, and facilitates hedging and other risk management activities.”

The regulator envisages a two-tier system for the reporting and disclosure of significant short positions held in shares. The first is a requirement to alert the regulator (private disclosure) once a net short position has reached a specified trigger threshold (0.2% of issued shares has been proposed). If the short position then reaches a second, higher threshold, the obligation falls to the regulator to make a public disclosure to the market.

“These proposals, if applied, would bring South Africa in line with global standards,” says Jean Pierre Verster, a portfolio manager at Fairtree Capital and non-executive director of Capitec. “It’s about strengthening the corporate governance and regulatory framework and that is not a bad thing.”

Verster runs both local and global long/short funds and has found short position disclosure useful when shorting European stocks, among others. “It assists in avoiding crowded shorts, which have a heightened risk of short squeezes that could lead to steep losses.” He is comfortable with the concept of better disclosure and says short sellers do not need to hide behind a cloak of anonymity to do what they do. “While hedge fund managers do bet on a particular share price decline, it is not in hedge fund managers’ interest to artificially drive down prices. You need to understand that relative to the long-only market, short sellers generally take very small positions.”

He notes that others in the market, including those in companies that are the target of short-selling and could see public announcements that their share has been shorted, may have to adjust to the idea. “For most hedge fund managers, there is nothing personal in a short-trade,” he says. “It is simply a risk mitigation strategy.”

The final date for submissions is January 15. From there FSCA will engage with the industry. No date or deadline has been set for the implementation of the proposed regulations.

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Shorting a share is often personal and has been used for personal gain often. One has to wonder if Elon Musk didn’t short his own share to take back control at a lower price, or if Richard Branson didn’t do the same when he used shareholders money to list the Virgin share and then bought back control when the share price collapsed. Anominity allows for all sorts of shinanegans so transparency is good and eliminates a level of possible corrupt practice by those in the “know”.

There is nothing personal in a short-trade,” he says. “It is simply a risk mitigation strategy.”-BS- it is used to artificially drive down a company’s share price, often through leaking negative, misleading and false opinions and ‘investigative’ reports. 36One and Viceroy, Benguella are alleged to npractice this.The object is to make money unethically.

Nothing inherently unethical about a short sale. If you expect an asset to rise in price, you would buy it, wouldn’t you, Joe? If you expect it to fall, you would sell it. The only difference between your selling an asset of your own that you expect to fall in price, is that the short seller doesn’t own the asset at the time he sells it.

And a short takes a risk: his estimate of the fall in price must prove correct not just in the long term, but within the agreed period for which he has borrowed the shares.

A short seller is not some evil manipulator. He’s a man with a contrarian view of an asset’s price.

Yup, but it is more difficult to make a share go up if you are long by spinning a false positive story. Fear on the other hand is a much more powerful emotion and it can drive a share down much easier if there is negative false news…especially after a Steinhoff, Enron or similar event

I am very grateful to short sellers. I am indebted to short sellers, not by them, fortunately. They are the ones who present me with the buying opportunities at the price-level where I see value. These valiant short sellers keep on selling the strongest stocks as they make new highs. My system is to buy the strongest stocks that make new highs when they make a big enough correction. So, the short sellers present me with many opportunities, to their own detriment most of the time. Short sellers basically work for me, and they pay for the opportunity to work for me.

So, please don’t ban these guys. They deserve our honour, gratitude and respect……and a moment of silence also….

I really don’t understand this whole thing. What is so evil about short selling.

Nothing evil about short selling. Short selling keeps companies honest. If you bullshit the public , retail investors, the short sellers will get you!

Fully agree BobbyJ, shareholders are already getting absolutely schhhmoked by top heavy, overpaid Management and Boards, about the only thing keeping them honest are shortsellers!!

Shorting is very important to a well functioning market.

How is it fine for management and the long asset managers to promote a stock but evil when a skeptic says the emperor has no clothes?

Second, the main reason very large passive funds can run zero or 0.1% expense ratios is that they lend out their shares to shorts.

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