New Short-Selling Regulations in Asia: Can American Investors Profit?

By Irwin Greenstein

Regulators around the world are tightening the noose around the scapegoat de jour, short sellers, with Hong Kong now ready to kick out the chair from under them.

The Standard reported today that Hong Kong is ready to impose the ban, which could take effect immediately. That means if you have money in Asian hedge funds, you could find yourself in some real trouble.

Other Asian countries such as Singapore, Japan, Taiwan and South Korea have temporarily banned short-selling activities completely. China’s long-standing ban on short selling never reached Hong Kong, but that could change imminently.

In Asia, and the rest of the world, short sellers are seen as the scourge of financial stability. Their job is to bet against a security, in effect fanning the flames of negative sentiment that drives down prices.

Now, Asian hedge fund and ETF managers are sitting on pins and needles to see if Hong Kong joins the ranks of short-seller vigilantes.

According to The Standard, word of the plan emerged after Hong Kong’s Securities and Futures Commission warned on Tuesday it was prepared to crack down on illegal short sales as the market situation became unstable.

The agency said it was prepared to “implement more aggressive measures in the event that any abusive short selling is identified.” Punitive actions would include market-wide controls, as actions against individuals or companies.

The current proposal by the Securities and Futures Commission is a follow-on to the existing ban of so-called “naked” short selling, which allows investors to sell stocks short without previously borrowing the stocks for settlement.

Whether or not a ban in Hong Kong will work remains to be seen. So far, the bans in other markets seem to have a negligible effect. It’s like giving a cancer patient a Band-Aid and a couple of Aspirins.

Symbolically, the squeeze on short sellers may make for good politics. But witch hunts are good sign that the world has gone mad.

Let’s face it: When the People’s Daily runs an article about shorting selling in China, it’s enough to make an investor stop dead in his tracks.

The People’s Daily was the propaganda machine of China’s Communist Party. Maybe that’s still true. But this time, instead of promoting Maoist rhetoric for the greater good, it’s writing about CYA trading tactics.

Along with the likes of the Wall Street Journal and the International Herald Tribune, the People’s Daily story ran on Oct. 6 — only a few days after Hong Kong said it was on the verge of banning short selling.

Is this a war of trading regulations? Hong Kong, along with many other markets, has halted or curtailed short selling - branding it as subversive to overall market stability.

As it turns out, China has a different take on short selling.

Whether or not this is a good thing for investors remains to be seen.

China’s securities regulator announced Sunday that it will soon launch short selling and margin trading for securities firms. China’s intent is to reverse the existing one-way trade on both Shanghai and Shenzhen stock markets.

As it stands, investors in those markets cannot capitalize on falling markets. If a stock drops, they can either wait it out or walk away.

The CSRC also hopes the new regulation will stimulate trading in general.

The CSRC is of the mind, however, that both short selling and margin trading would in fact help cushion a declining market by giving investors to also profit from falling prices.

It will select the first securities firms based on their net capital — a smart move given the number of bankruptcies and near failures we’ve seen the U.S. and Europe.

A CSRC statement released on Sunday said that the trial project was open to all kinds of securities firms across the whole country.

If the experiment is viable, margin trading would be normalized in all securities firms, it said.

The changes have already been approved by the cabinet.

For American investors, perhaps the best way to test out the new regulations is through composite indexes for the Shanghai and Shenzhen markets.

The SSE Composite Index (Shanghai:000001.SS) and the TSEC weighted index (Taiwan:^TWII) can be traded with ADRs here in the US.

Given the cautious approach by the CSRC, the impact on the indices will probably be minimal. Still, for American investors it could point the way to future profits.

Comments

[Clavis:]

Mmmm, very interesting, never realised that there was no shorting in those markets.
Nothing wrong with shorting as a counter balance, naked shorters should have a lifetime ban imposed but I can see problems arising out of the leverage factor; should this be allowed; let alone the margin concept.
My conclusion is that less than 20% of persons using margin accounts; thus saving cash; understand that their shares are loaned out, possibly to be used against their current position and there is always the possibility of a margin call which equals pay up now or we sell a proportion of them to cover the call.

2008 Oct 07 09:10 AM

[James Wilson:]

I disagree. Make the shorts have a vested interest in the stock they are shorting kust like the people who own the stock.

Shorts are why insiders view stock holders as outsiders and strangers in most companys when they hand out huge stock options as bonuses and only pennys in dividends.

2008 Nov 06 04:33 PM