Hedge Fund Standards Board’s response to the CESR proposal for a Pan-European short selling disclosure regime
CESR lists several areas where it considers that the benefits of more short selling transparency outweigh the cost:
· Detecting market abuse
· Reducing risk of disorderly markets
· Information provision to assist price discovery
HFSB has a differentiated view on transparency of short selling. The subsequent paragraphs provide an assessment of each of the areas highlighted by CESR in more detail.
Detecting market abuse
CESR considers that improving the transparency of short selling would help to deter market abuse. HFSB agrees that regulators need to have tools to assess and monitor issues in relation to this, but it is important to highlight that no public disclosure requirement arises from this. It is only the regulator who might have additional information needs (or access to information, if needed).
HFSB would like to highlight that any potential negative impacts need to be assessed, including loss in market efficiency (a. discouraging information acquisition, b. encouraging herding) if disclosures are intended to be public.
Reducing risk of disorderly markets
It does not appear that there is a permanent threat to disorderly markets in relation to short selling at all. Indeed, the crisis in fall 2008 has not been caused by short selling. Therefore, it is difficult to build a case for a permanent reporting/transparency regime in relation to short positions.
However, regulators should be in a position to collect relevant data during times of distress. The focus should then lie on systemically relevant sectors (such as banking, insurance) and aggregate data. Obviously, this data is only relevant to the regulators (similarly to market abuse detection) and there is no case for public disclosure.
Information provision to assist price discovery
CESR mentions among the benefits of enhanced transparency that short selling conveys important information (eg that a stock is overvalued) to the market to assist price discovery. Along those lines, one could equally argue that on every short sale, there is a buyer, equally conveying important information to the market (eg that the stock is undervalued). Therefore, the “net signal” is actually not indicative at all of whether the stock is over or undervalued. In addition, short selling is used in
Hedge transactions, where only the relative directional movement of a shorted stock matters (in relation to the respective long position), irrespective of whether the market rises or falls.
Therefore, HFSB would argue that all information is reflected in today’s market price, irrespective of whether short selling has occurred or not. The aggregate impact of short selling might have reduced that price, but thereby this information is included in today’s market price.
Portraying that short selling activity is a signal to other investors that a stock is overvalued is only true under the assumption that the parties short selling the stock have better information than those buying the stock. If some investors assume that mostly hedge fund managers engage in short selling and that hedge fund managers have better information, then they might give more weight to the fact that short selling occurs (rather than just assuming that today’s price is the best estimate of future value).
The problem arises if regulators now argue that short selling can convey a signal, because they implicitly tell market participants that short sellers indeed have better information, and thereby encourage herding behaviour based on short selling disclosures. HFSB believes that it would be an arbitrary decision to enhance disclosure on the grounds of “additional valuable information” and that this might lead to market distortions/less efficient price discovery.
In summary, there is no case for further disclosure on the grounds of “informational benefits” or “assisting price discovery”.
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