Published December 1, 2008

Short- selling disclosure proposals require tweaking

By R SIVANITHY
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THE reasons why it is best to adopt a disclosure-based approach to short-selling in the local stock market rather than an outright ban have been covered in several articles in The Business Times over the past two years (Hock Lock Siew, July 21, 2006, 'Share, warrant shorting: more can be done'; Hock Lock Siew, June 18, 2007, 'Being fairer to investors'; Hock Lock Siew, Jan 2, 2008, 'Areas that could do with greater disclosures in 2008'; Editorial, June 10, 2008, 'Time to make short-sell positions known'). So it was no surprise that, in its latest public consultation paper on the subject, the Singapore Exchange (SGX) has opted for a disclosure- based approach.

Hong Kong, the US and Australia have already implemented similar disclosure-based measures with little or no adverse impact on their respective markets.

To summarise, there will be no outright ban on the activity nor will it be made illegal; instead, SGX is looking to install a long-term, disclosure-based framework with subtle but nonetheless onerous disclosure deterrents with complementary legislation. Once all the elements are in place and the system up and running, the resultant information should enhance transparency and prove useful to the investing public.

A few points, however, deserve closer attention. First is the need to enhance the latest proposals with measures to completely eradicate short-selling of warrants.

A quick glance through the list of securities to be bought-in every day shows that although the amounts are small, naked short-selling of warrants is a daily occurrence. Moreover, anecdotal evidence from warrant issuers is that intraday shorting is even more common and is a greater headache as far as they are concerned. Both forms of warrant shorting have to be stopped.

Unlike shorting of shares - for which making disclosure more onerous would probably be adequate to rein in some of the activity - there has to be an outright ban on warrant shorting. The reasons for taking a stricter approach with warrants have been discussed in this column before (Hock Lock Siew, Oct 12, 2006, 'Why SGX must strictly deter short-selling of warrants'), so there's no need to go into great detail here. In a nutshell, shorting of warrants creates huge distortions for issuers because it interferes with their ability to properly hedge themselves and provide effective market-making services, while shorting of warrants close to expiry causes massive settlement headaches once expiry is reached.

The legislative framework that the authorities are proposing to introduce to enforce the latest proposals thus has to address warrant shorting, with sufficiently strict penalties for those who are found to be repeatedly short. It may even be necessary to go as far as Hong Kong - where, in extreme cases, a jail sentence can be imposed.

Second, disclosure of substantial short positions. Under the present proposals, one per cent of issued share capital is the threshold for a position to be considered 'substantial' and thus liable for disclosure to SGX and the Monetary Authority of Singapore (MAS).

The exact figure is now open to debate and public feedback, and so may be changed later. However, the important point to note is that, whatever the final percentage, these positions are only to be disclosed to the authorities and not necessarily to the public. Should this information be made public?

Our view is probably not, though it's best to leave this option open and exercisable at SGX's or MAS's discretion. As the exchange noted in its paper, the public is more interested in daily short-selling volume rather than the identities of short-sellers, so perhaps it's best to adopt a case-by-case approach to this issue.

Third, it's important to note that the daily disclosure of short positions which is being proposed includes intraday positions that were covered before the end of each day.

SGX itself recognises that this inclusion could result in an unfair overstatement of the true short positions in that particular stock, so it would be advisable to report intraday shorts separately and not aggregate these figures with the rest.

Finally, some market players are concerned that the measures could affect liquidity and obstruct their daily activities. Hong Kong, the US and Australia have already implemented similar disclosure- based measures with little or no adverse impact on their respective markets, so if and when SGX's latest recommendations take effect - SGX estimates it will be at least nine months before any changes appear - there's no reason to expect any major disruptions here.

With a little fine-tuning to suit local circumstances, SGX's latest proposals are clearly a step in the right direction.