Thinking | 23 September 2008

Naked and covered short selling banned

On Friday 19 September, ASIC announced an interim package to deal with short selling of securities which included regulatory guide 196, an overview of short selling under the Corporations Act 2001 (Cth) (Act). It outlined the general prohibition on short selling and clarified the exemption where a market operator permits short selling under its operating rules.

Naked short selling occurs where the vendor does not have ‘a presently exercisable unconditional right to vest’ the security being sold. Usually, short sold shares would then be purchased (often at a lower price) to be supplied to the purchaser prior to settlement. Covered short selling means that the vendor does have ‘a presently exercisable unconditional right to vest’, that particular security despite being a short sale, for example, by entering a lending agreement for that specific stock.

The Australian Securities Exchange (ASX) formerly facilitated naked short selling by designating certain securities as ‘Approved Short Sale Products’. As part of the interim package, the ASX (in accord with ASIC) announced it will effectively abolish naked short selling under existing ASX rules. From the opening of trading on Monday, 22 September 2008, the ASX removed all securities from its Approved Short Sale Products List for naked short sales.

The ASIC interim package also included ASIC Class Order 08/751 which outlines new disclosure requirements for covered short selling for the customer and broker. The broker must ask the client if it is a covered short sale before taking the order. A customer will be obliged to inform the broker that a transaction is a covered short sale and the broker must then notify the ASX.

ASIC also has the power to exempt and modify the short selling provisions in relation to particular persons or particular financial products, and on Sunday 21 September, ASIC announced that covered short selling would also be banned (contrary to its announcement on Friday).

However this will be reassessed in 30 days to possibly re-allow it for non-financial stocks. The reasoning given by ASIC is to maintain fair and orderly markets in the current financial crisis.

The confusion caused the regular market opening to be delayed by almost an hour yesterday as the ASX waited for ASIC to tweak the ban and exempt those with existing hedge positions. It was announced that:
“ASIC will provide a no action letter for hedging of existing positions of market makers arising from their client business. ASIC will settle terms of that letter today, but it will be to the effect that the prohibitions on covered short sales will not apply to hedging a position that was taken by an entity prior to 22 September 2008 as part of its business of dealing as principal in equities, options or derivatives (whether OTC or exchange-traded) to fulfil orders received from clients or to respond to a client’s request to trade, in each case before that date.”

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Harry New

Harry leads our financial services team and focuses extensively on financial services law and corporate advisory.

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