City Column: Rule change short on logic
4 Aug 08
Angus McCrone believes hasty Stock Exchange action affecting investors who gamble on share price falls is ill thought-out and could be unworkable
by Angus McCrone
About a decade ago, there was a moment when Abbey National was worth more than Thailand – or at least the entire Thai stock market. This year, it is a very different picture. For much of July, one of the UK’s leading mortgage lenders, Bradford & Bingley, was worth little more than five Monet paintings.
The 90 per cent fall in Bradford & Bingley shares in a year has been one of the many astonishing features of the 2007-08 credit crunch. The plight of the former building society has also helped to bring about a controversial change in London’s stock market rulebook.
In late June, the Financial Services Authority (FSA) introduced new rules forcing investors holding short positions equivalent to 0.25 per cent or more of the equity of a company undertaking a rights issue, to disclose that position.
The move was partly an attempt to address an old anomaly – that large short positions generally remained invisible – and partly an opportunistic attempt to help several beleaguered banks that were trying to bolster their balance sheets by raising money in rights issues. Unfortunately, the change leaves the City rulebook even less logical than it was before.
In its statement announcing the step, the FSA said: “In current market conditions, there is increased potential for market abuse through short-selling during rights issues. As a result, there has been severe volatility in the shares of companies conducting rights issues. This is potentially damaging not only to the issuers in question, but also to confidence in the overall fairness and quality of the UK market.”
Directly as a result, several hedge funds quickly had to disclose short positions in two banks conducting rights issues – HBOS and Bradford & Bingley (B&B). Harbinger Capital of the US admitted to a 3.3 per cent short position in HBOS shares, while GLG Partners of London was short 4.1 per cent of B&B. Seven other funds disclosed lesser short positions, some as small as 0.28 per cent.
The FSA admitted that short selling was “a legitimate technique which assists liquidity and is not in itself abusive”. It might have added that it is very risky – funds and speculators taking short positions in shares by borrowing stock or using contracts for difference (CFDs) often get their fingers badly burned when strong buying pushes the share price back up.
The regulator tried to assuage criticism by saying that the new rule “may be subject to change in the light of experience”. However there was also an undercurrent from the FSA suggesting that some short-selling was connected to the spreading of false rumours.
The problems with the new rule are various. An obvious one is the logic of making it apply during rights issues and not at other times. The clearest episode of a “bear raid” on a UK stock was on 19 March when shares in HBOS slumped 17 per cent on false rumours that it had sought emergency funding from the Bank of England. HBOS was not conducting a rights issue at the time, so the new rules would not have applied.
A second argument concerns fairness. Investors owning shares in a quoted company only have to disclose when their holding reaches 3 per cent. On 2 July, this was extended to those holding long positions in companies via CFDs. But why should short sellers in a rights issue have to disclose at 0.25 per cent, when long holders of only have to declare at 3 per cent?
The third problem could be confusion. On the face of it, the short selling rule drags private investors going short of small stocks via spread bets, into the disclosure regime – when the companies concerned are in rights issue periods. That looks like a recipe for administrative chaos.
Also, larger investors using short positions as a hedge – either when they are involved in sub-underwriting the issue, or when they are buying rights – could also get roped into disclosing. If so, the information would be worse than useless to the market as a whole.
A better response to the rights issue problem would be for the authorities to shorten the length of these time-honoured exercises from the current eight weeks or so. That would limit the scope for destabilising investor strategies during issue periods.
Meanwhile, the trigger level for long and short position disclosure should be harmonised at three per cent of a company’s stock.