The new short selling regulations that are circulating among European law makers are primarily targeted at hedge funds, but with the Securities and Exchange Commission (SEC) lifting the ban in the U.S. after its recessionary enforcement, the ripples could reach U.S. traders and market makers like Knight Capital Group (NYSE:KCG) might be and forced into the transparency of revealing their trading positions.
Other market makers and trading firms like Stifel (NYSE:SF), Jefferies (NYSE:JEF), Raymond James (NYSE:RJF), and Greenhill (NYSE:GHL) could also be forced to showing their “hands” at the card table.
The action in Europe reportedly goes well beyond the efforts of regulators and policy makers in the U.S. As part of the Dodd-Frank financial reform act, the SEC is drafting rules that would require hedge funds to disclose greater detail about their positions, leverage, and performance. The information would not be made public, but that hasn’t stopped it from leaking onto the Internet in the past.
While public and private equity and hedge funds will be affected, I believe the regulations could also include market makers who carry substantial positions on the books and use short selling as a hedge.
Some hedge fund managers don’t mind revealing their short positions against any particular company and others are adamant about privacy. But big investors no longer have a choice in France, where regulators started requiring money managers to disclose on a daily basis the stocks they bet against in the country.
This month the Autorité des Marchés Financiers, the French financial markets regulator, began requiring hedge funds and other investment managers to disclose their short positions when they reached 0.5% of a company’s outstanding stock.
Short selling for big institutional traders has always been treated as a “closely guarded” strategy.
The French regulation parallels a plan by European Union (EU) regulators who, in the wake of the financial crisis, want to monitor the potential risks of short-selling. The EU is considering a proposal that would require all member countries to publish details on investors’ short holdings.
Investors short stocks for many reasons. They may think a company’s shares are overvalued and headed for a fall. Or they want to cut risk in their portfolio. Short selling has always been a “for” or “against” proposition. For me, I’ve also felt it provided liquidity and kept value pricing in line. Others feel it speeds up stock losses, adding unnecessary volatility in times of market stress. I admit that can be a consequence of a company that has too many shares sold short.
When a company has a short percentage that is large, say over 10-15%, a single rumor can cause a stampede. In a more moderate world, buying a put as it were to decrease exposure has always seemed a fair practice to me.
During the end of the recession, the U.S., the U.K., France, and Germany banned short selling all together in shares of certain companies. Since then, the bans have generally been lifted.
The Managed Funds Association, an equity trade group in the U.S., has sent letters to EU regulators asking the European authorities to maintain the records privately, or post them anonymously, or in aggregate.
I don’t see transparency as the end of the world as some do, but I do think regulators really need to think this through. Privacy is one on the pillars of a free market.