Ideas & Debate

Why short-selling rules could limit trade at NSE

Some rules on short-selling could have the negative effect of limiting dealings at the bourse. FILE PHOTO | NMG
Some rules on short-selling could have the negative effect of limiting dealings at the bourse. FILE PHOTO | NMG 

Cheers to the Capital Markets Authority for midwifing The Capital Markets (Securities Lending, Borrowing and Short Selling) Regulations, 2017.

Shorting, or short-selling – a practice involving an investor borrowing shares and immediately selling them, hoping he or she can scoop them up later at a lower price, returning them to the lender and pocketing the difference – is a welcome development.

That said, allow me to share a few thoughts on some aspects of the said regulations.   

On market intervention, the regulator took this position: “The authority may suspend the short sales of a security or impose controls on the prices that may be input on short sales of a security to maintain or restore the fair, efficient and transparent trading in the security.”

Now, this is a self-defeating stance. Creating emergency powers to “intervene” runs against the same goals short-selling is aimed to achieve.

It’s also a well-known fact that short-selling bans introduced in the United States of America, United Kingdom, Germany, France, Italy and other European countries in the wake of the 2008 financial crisis failed miserably.

Besides, both market studies and real-life experiments show that short-selling eventually aids in achieving market efficiency. To attempt to intervene will in effect achieve the opposite. 

On who is allowed to short, the regulations state that, “short selling transactions shall only be carried out by regulated persons or any other person specified by the authority”.

It goes further to identify the regulated persons as including “pension funds, insurance companies, investment funds, exchange traded funds and commercial funds”.

Now, such a restriction seems well-advised as it’s also a widely accepted practice. However, locking out individual investors entirely seems unfair (if the “any other person” category fails to accommodate them).

This is because not all individual investors are the same, not all have the same needs and not all are unsophisticated.

Consider this; an individual investor with a huge long-term concentrated equity position. How does he/she hedge against unnecessary losses if he/she’s not allowed to short the same stock albeit on a temporary basis? Think Trans-Century. Think ARM Cement #ticker:ARM. Think WPP Scangroup #ticker:SCAN.

Some of these guys have suffered huge losses before and are badly exposed without a hedging platform to “neutralise” their positions. They deserve a right to play too. If not, at least an alternate platform such as put-options will do. 

The rules were also silent on a unique matter concerning regulated persons and their relationships to potential short-sale candidates. Would regulated persons ever short their close associates?

Take for instance Britam Asset managers, GenAfrica Asset managers and Nabo Capital (Centum #ticker:ICDC, Longhorn Publishers #ticker:LKL), National Social Security Fund (National Bank of Kenya #ticker:NBK), CIC Asset Management (CIC Insurance group #ticker:CIC), ICEA Lion Management (NIC Bank #ticker:NIC), Standard Chartered Investment (Standard Chartered Bank #ticker:SCBK), Stanlib Kenya (Stanbic Holdings #ticker:CFC, Stanlib Fahari) and Co-op Trust Fund (Co-operative Bank #ticker:COOP).

Can they be trusted to put the interests of their unit trust holders first before their shareholders? I think not. With that said, I think short-selling will constitute a minute part of the investment business.