Short selling — the practice of borrowing shares and selling them to profit from anticipated price declines — is almost universally accepted as beneficial for the functioning of financial markets. It supports liquidity, enables risk management and aids price discovery (jargon for the mechanism through which security values are determined). It has an image problem, though.
A whiff of controversy hangs around the business. Much of that can be attributed to the activists who have dominated headlines with high-profile bets against companies over alleged governance or accounting issues, such as Hindenburg Research’s Nate Anderson, Citron Research’s Andrew Left or Carson Block of Muddy Waters Capital. Short sellers are also often regarded with suspicion at times of financial turmoil, when they are seen as exacerbating downward pressure. Countries from the US to Australia to China have imposed temporary bans or restrictions on short selling during market meltdowns, usually with limited success.
Shorting is also a risky business. Traders can suffer painful losses if they get caught in a “short squeeze,” as those betting against US meme stock Gamestop Corp. experienced in 2021. Warren Buffett is among those who have cautioned investors over the perils of short selling.
In reality, activist short sellers are a niche. The vast bulk of the market isn’t made up of marquee bets by celebrity skeptics. It’s a more mundane activity in which thousands of hedge funds and other investors seek to profit from market mispricing by selling short stocks that they judge to be overvalued, often counter-balanced by long positions elsewhere. That’s why it makes sense for market overseers to remove any frictions that may inhibit firms from trading.
At first glance, the overhaul unveiled by the UK Treasury last week doesn’t appear to match the grandiose rhetoric of its December consultation document, which talked of “building upon our historic strengths to renew the UK’s position as one of the world’s pre-eminent” financial centers. The government announced what it billed as two key changes. One will restore the threshold for reporting net short positions to the regulator to 0.2% of a company’s issued share capital from 0.1%. The EU cut that level in March 2020 as markets plunged during the pandemic. A 0.1% change hardly looks like the stuff of revolution.
There’s no seismic break with the European model either. On point after point, the UK decided that the EU system was sound after all. That’s unsurprising when you consider that London, as the bloc’s most important financial hub pre-Brexit, doubtless had an influence in the writing of these rules in the first place. The 856 respondents to the government’s call for evidence “largely did not see the need for a fundamental reform.” There was no appetite for allowing “naked” short sales, when an investor sells without first having borrowed the stock. Market makers will continue to be exempt from the reporting regime. And there is no change to the regulator’s emergency powers.
It would be rash nonetheless to dismiss the significance of the revamp. The most far-reaching adjustment is to remove the requirement for public disclosure of individual investing firms’ net short positions once they reach 0.5% of a company’s shares. This will be replaced by disclosure of the aggregate net short position. So, for example, if fund A and fund B are both short 0.5% of company C’s shares, then the regulator will report that there is a 1% net short position in company C, without identifying which investors hold those positions.
Hedge funds have greeted this change with unbridled enthusiasm. Adam Jacobs-Dean, global head of government and regulatory affairs at the Alternative Investment Management Association, told me that public disclosure had been a “massive source of contention,” and the changes were regarded as huge by the industry. Disclosing individual positions enables other firms to copy the trading strategies of rivals and increases the risks of short squeezes, asset managers argued during the consultation. Notably, there was a split on this issue between fund managers on one side and investment banks and securities lenders on the other. The government came down in favor of the buy side.
Britain isn’t finished with its short-selling overhaul. The Treasury is also considering rolling back EU curbs on naked short selling of sovereign debt, which is the subject of a separate consultation. That looks brave, given the turmoil triggered last year by the short-lived Liz Truss government’s plan for unfunded tax cuts, which caused gilts and the pound to crater. The government says the short-selling restrictions, imposed more than a decade ago in response to Europe’s debt crisis, have harmed liquidity.
We will now have to wait and see how the easing of short-selling rules, part of a wider package of financial reforms, helps to revive a London equity market that has been losing relative appeal. This is how the Brexit dividend, if it is ever to be found, will be won: slowly and incrementally.
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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Matthew Brooker is a Bloomberg Opinion columnist covering business and infrastructure out of London. A former editor and bureau chief for Bloomberg News and deputy business editor for the South China Morning Post, he is a CFA charterholder.
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