24 September 2008

ASIC's shorts exposed

The long and the short of it

It has been a curly week for the Australian Securities and Investments Commission. ASIC has made a right hash of a decision about what to do about short selling of securities quoted on Australian securities markets.

Setting aside the content free dialogue that has been going on for over 6 months in the media; prompted by throw away remarks from our Federal Treasurer, Wayne Swan, about the Government's forever imminent legislative crack down on "short selling"; now that the Government and ASIC have had their hand forced by international attempts to act in a co-ordinated way to stabilise markets and reduce panic, ASIC stuffed it up.

A brief chronology:

  • Thursday, 18 September US Treasury Secretary Henry Paulson announces an $800 billion liquidity injection into the for the US financial system, in an attempt to restore confidence in the US banking system after the failure of Lehman Brothers, (amongst other stuff).
  • Friday, 19 September, ASIC issues Media Release 08-204 , "Naked short selling not permitted and covered short selling to be disclosed", this effectively announced two things:

    (i) A new
    ASIC Regulatory Guide 196, making it clear that ASIC considers naked short selling is illegal under section 1020B. Naked short selling being selling securities without "a presently exercisable and unconditional right to vest the product in the buyer"; and

    (ii) ASIC has exercised its power under section 1020F of the Corporations Act to modify section 1020B, relating to short selling, by
    class order CO 08/751, adding a new provision, section 1020BC which had the effect of requiring stock brokers to ask their clients when receiving orders to sell securities whether they were selling borrowed securities, rather than ones they owned outright, ie covered short selling, and if so reporting that to the exchange. That is they beefed up the disclosure obligations on covered shorts.

  • Sunday, 21 September, ASIC issue Media Release 08-205 which announces a change to the position announced on Friday 19 September. Instead of just requiring covered shorts to be reported, it now issues a new class order CO08/752, modifying CO08/751 of 2 days earlier, to make all short selling, even covered short selling illegal for at least 30 days.

  • Monday, 22 September, the Australian Securities Exchange (ASX), is unable to open at its scheduled 10 am opening, because of unresolved issues about existing short positions in the market, whether the writers of put and call options are shorting if they don't hold the stock, whether funds who hedge and arbitrage with short positions are able to continue, ...etc..etc

  • Tuesday, 23 September, ASIC issue Media Release AD 08-22, which seeks to clarify and create a number of exceptions to the previously announced blanket ban on covered shorts. In order to to this it issues another two new class orders CO08/753, and CO08/764 , further modifying CO08/751 to accommodate these hastily conceived exceptions.

In addition to the simply ham-fisted chopping and changing which makes them look like a bunch of badly informed and incompetent amateurs, it also looks like ASIC has also ended up getting it wrong anyway, with its general prohibition on all short selling on Sunday 21 September.

If, as seems to be the case, ASIC felt the need over the weekend to change the position it had announced on Friday 19 September that banned only naked shorts, because of the broader position being adopted in the US, UK, Ireland, Canada, France and Germany, then why didn’t it do the same as they did, and just extend the prohibition to covered shorts over securities in financial sector stocks ? ASIC instead extended its prohibition to shorting of securities in all listed companies and managed funds, stapled products.

ASIC seems to little explanation for this dramatic difference in its approach from the rest of the world other than the suggestion that the size of our market made us vulnerable to predatory shorters. Such an explanation is decidedly thin since it has been going on under ASIC's nose without intervention for years. In the circumstances it can be legitimately speculated that ASIC’s singular change over the weekend, occurred because it, or its masters in Canberra, were lobbied hard then by the likes of Macquarie and Babcock & Brown, who were vulnerable to shorters, and who also had a range of securities quoted on the ASX in addition to shares in themselves, such as hybrid, stapled, and managed fund combinations. ASIC was apparently unable in the time available to figure out an appropriate and logical mechanism to identify by category or by a list which stocks in quoted on the ASX were at risk from aggressive shorting and whose failure as a consequence might effect our financial system. ASIC accordingly seems to have resorted in the circumstance to just banning all short selling rather than try to finesse this important distinction. ASIC’s extended position otherwise doesn’t seem to have a good rationale.

The market’s price discovery process are not ordinarily interfered with just because regulators don’t understand them fully or disagree with the prices arrived at by traders. Prudent regulators might, just, justify an intervention in dispassionate market price setting processes where the integrity of the financial system may be imperiled by pricing irrationality, resulting in a run on a bank or a panic external to the actual market for a particular financial sector firm’s securities. This suggests however that any such intervention should be confined to stocks that have those characteristics. Does it really matter to market regulators if XYZ Teaching or Blue Sky Mining is aggressively over sold by shorters? It’s either a very cheap buy or it dies. That’s the market’s verdict.

Some one needs to grab ASIC by the shorts to sort this mess out. It needs to be bring itself back into line with the rest of the free world at the earliest opportunity, presumably when the inital 30 day period of this general prohibition elapses.

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