Uncertainty continues around EU shorting rules
ESMA recently announced a consultation into the market-maker and primary dealer exemptions contained in the rules, which are due to come into force on November 1, 2012. “Nobody quite knows what the market-maker exemption is and this is causing frustration among some managers and broker-dealers. Some of the mid-sized to smaller US hedge funds are particularly behind the curve when compared to some of their peers in Europe,” commented one major brokerage firm.
The new rules have raised consternation among market commentators. Hedge funds will be required to disclose privately to national regulators whether they intend to short more than 0.2% of company shares. Managers will also be forced to publicly disclose net short positions exceeding 0.5% of a company. Disclosure could prevent hedge funds, particularly fundamental long/short managers from obtaining corporate access, a point articulated in an Oliver Wyman report in 2011.
Robert Mirsky, head of the hedge funds group at KPMG in London, said disclosure could also lead to copycat trading. “Managers are concerned about copycat trading because they are not reporting aggregate data but position level data in near real-time. This presents a serious issue,” he said.
Kumar Panja, head of the prime brokerage consulting group for EMEA at J.P. Morgan, said copycat trading was a possibility but acknowledged manager concerns about the issue were premature. “There is debate about whether public disclosure will lead to copycat trading or crowded trades. If a well known manager holds a large short position in a company, it is possible that other managers or investors could follow suit. However, it is still too early to say whether this will happen,” said Panja.
Research published by Dr Adam Reed, professor at the Kenan-Flagler Business School at the University of North Carolina, acknowledged disclosure of shorts does lead to follow-up shorting activity, particularly if the discloser has significant AuM. However, the study concluded this did not have a massive impact on stock movements.
Others believe the rules could hurt sec lending and cause a liquidity squeeze. “While I doubt liquidity will dry up, there is a possibility there could a squeeze in certain asset classes,” said one source in the market.
Mirsky reckoned the rules could deter US managers from trading on EU markets. “There is a high risk these rules could impact market liquidity and make it harder for people to trade on European markets. A lot of US managers, for example, have said it is just too hard to trade in Europe so might shun the region going forward,” he said.
The rules also prohibit naked short-selling of sovereign CDS. European politicians have routinely blamed short-selling and CDS trading for exacerbating some of the woes facing the more embattled eurozone economies despite countless research papers dismissing this. A paper commissioned by the European Parliament and published by German academics in September 2011, for example, said a ban on naked CDS would hurt liquidity and hinder price discovery.
Several countries – France, Italy, Spain, Belgium, Greece, South Korea – have all imposed restrictions on short selling over the last 18 months, often to little avail. The French, for example, banned shorting of its financial institutions only to see credit rating agencies downgrade Credit Agricole, Soc Gen and BNP Paribas.
The divisions within the EU over shorting bans are apparent. The latest batch of shorting bans were only adopted by a few member states, and even those varied in scope. “I doubt regulators will impose a pan-EU shorting ban given the internal politics,” commented one broker dealer.