Published September 24, 2008

COMMENTARY
SGX short-selling measures fall short

Regulator hasn't addressed the heart of the short-selling equation: the quantities and names of scrip lent to short-sellers

By RSIVANITHY
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AFTER resisting for years suggestions made in this newspaper to improve transparency relating to short-selling and the buying-in market (BT, Nov 16, 2004, 'Revive cash market to run in tandem with buying-in'; April 24, 2007, 'Time for exchange to relook buying-in process'; and June 18, 2007, 'Being fairer to investors'), the Singapore Exchange (SGX) on Monday finally caved in - not to calls from the media but presumably to pressure from the public to accompany other exchanges that have banned 'naked' short-selling.

Thankfully, SGX has at least stayed true to its long-time position that no outright ban is needed as long as the deterrents are sufficient. And news that there will be daily disclosure of outstanding short positions and the buying-in list is welcome.

However, in trying to demonstrate solidarity with its peers around the globe, SGX has acted too hastily, in imposing a minimum $1,000 fine on failed trades which have to be bought-in later.

Worse, it appears from buying-in figures released under the new measures that naked short-selling is not a problem in the local market - which in turn means that the focus should really have been on disclosure of covered positions. Unfortunately, this was not addressed.

Let's consider, first, the official reluctance to outlaw shorting. This is a controversial stand given that other countries are in effect making shorting temporarily illegal.



But, on balance, it is the correct approach since in a free market, there should be minimal regulatory interference to bias prices in any particular direction. Still, recognising that the sale of something not owned can raise moral and ethical issues, the exchange has always had in place a set of rules aimed at deterring the activity via punitive buying-in costs.

That this system is actually working well in discouraging naked shorts can be seen from the list of bought-in stocks yesterday that was published on SGX's website. These were for positions left uncovered (or naked) on Wednesday, Sept 17, when the Straits Times Index plunged 42 points to 2,419 and when $1.4 billion was traded.

Yesterday's buying-in, however, involved only 45 counters excluding warrants, with the smallest buying-in quantity being 320 shares of M1 and the largest being 138,147 shares of China Hongxing Sports. Can such small quantities be reasonably said to have aggravated the drop that day? Also, buying-in on Monday, which was for naked shorts on Tuesday, Sept 16 - when the STI dropped 25 points and the market traded $1.6 billion - amounted to only $7.4 million, of which $4.2 million came from one stock (China Hongxing Sports).

In other words, naked shorts accounted for less than 0.5 per cent of turnover that day - again, insignificant.

Unnecessary move

This means that buying-in details released by SGX so far confirm that naked short-selling cannot be a major factor in aggravating the market's declines and that the exchange's deterrent mechanism is functioning properly.

(Of course, intra-day shorting could aggravate a downward slide but these sellers have to buy before 5pm, and in so doing provide support before the end of the day.)

The final proof came yesterday when, despite the new measures, the STI plunged 67 points or 2.7 per cent to 2,476.

All of this suggests that the latest move to fine naked shorts at least 5 per cent of their trades subject to a $1,000 minimum is clearly an overreaction and not necessary. None of the figures above suggests an intent to systematically engineer a collapse, so the parties that will end up being penalised will most probably be inadvertent, innocent retail investors.

Moreover, SGX has not addressed the heart of the short-selling equation: the quantities and names of scrip that have been lent to those seeking to short the market.

Known as 'covered' shorts, information relating to these positions would be just as useful to the public as releasing the list of stocks to be bought-in every day.

Hong Kong recognises this and, twice a day, its exchange releases a report summarising the stocks which have been borrowed and the quantities lent.

Here, SGX and several other houses offer scrip borrowing and lending (SBL). The exchange should compile data on outstanding positions from all SBL providers and publish this information as soon as possible after the market closes every day.

This was not addressed in the Monday announcement; instead, all energies were aimed at the insignificant naked shorts.

You'd have to say that insofar as the intention was to enhance disclosure and help investors' decision- making, SGX's Monday move to fine naked shorts has not only missed the mark, it has also fallen short.