New Short Position Reporting: Analysis of Hong Kong Proposals
March 10, 2010
By Timothy Loh, Henri Arslanian and Sarah Wong
The Hong Kong Securities and Futures Commission has unveiled
new proposals to increase transparency in short positions. Other jurisdictions have introduced
similar proposals but it is questionable whether Hong Kong needs to follow
suit. In this article, we summarize the proposals and provide our insights on them.
TIMOTHY LOH | Financial Services & Law Review
Vol. 4 (2010) at p. 7
On March 2, 2010, the Securities and Futures
Commission ("SFC") released its Consultation Conclusions on Increasing Short Position Transparency ("Consultation Conclusions").
The Consultation Conclusions outline imminent proposals to
introduce subsidiary legislation which will establish new obligations for
market participants to disclose short positions.
SUMMARY OF PROPOSALS
The SFC intends to release proposed language for
the subsidiary legislation in a separate future consultation. In the meantime, in broad terms, the
proposed subsidiary legislation will require a market participant to disclose
at the beginning of each week material short positions held by them at the
close of trading at the end of the previous week.
For this purpose, a material short position is a
gross short position which exceeds 0.02 per cent. of the market capitalization
of the company or the value of which exceeds HK$30 million.
Limited universe of stocks –
Short positions will only include short positions in companies comprised in the Hang Seng Index or the H-Shares index
and short positions in financial companies. Short positions otherwise of companies listed on the Stock
Exchange of Hong Kong ("SEHK") will not count as short positions. No derivatives – Short positions will only include short
positions in the physically settled cash market. Synthetic short positions arising from derivatives trades
will not count as short positions.
Once disclosed, the SFC will release short position
data to the public on an aggregated no-names basis though it will delay
implementation of public disclosure for the first few months.
CURRENT LAW
The current law provides for short selling
transparency in 2 principal ways, namely transaction reporting and position
reporting.
Transaction Reporting
The Securities and Futures Ordinance ("SFO") creates a transaction reporting
system which requires all persons handling a short sale order for execution on
the SEHK to notify the executing broker that the order is a short sale and all
traders executing short sale orders on the SEHK to input the order as a short
sale.
Disclosure of Interests Regime
The SFO also establishes a disclosure of interest
regime. This regime includes a position reporting system which requires (i) persons (i.e. substantial shareholders) who have an
interest of 5 per cent. or more in the relevant share capital of a company
listed on the SEHK to notify the SEHK of any short position of 1 per cent. or
more, and (ii) directors and chief executives of a company listed on the SEHK to notify changes in any short
position they have.
Limitations in Existing Law
The current law provides only limited short
position transparency. The requirement for office in a company or an initial 5 per cent. threshold
interest in the relevant share capital of a company as a pre-condition to short
position reporting sets a high reporting threshold in practice. A market participant who does not
borrow at least 5 per cent. of the relevant share capital is unlikely to
trigger any reporting obligation.
At the same time, the requirement for short sales
executed on the SEHK to be marked as such does not provide short position
transparency. A short sale does not necessarily result in a short position (e.g.
the seller has a long position through a derivative) and a short sale may be
offset by a buy order which is not subject to any disclosure obligation.
LIMITATIONS IN NEW PROPOSALS
While the proposed subsidiary legislation will
increase transparency on short-selling by providing aggregate disclosure of
selected short positions, transparency gains are in some ways limited.
The proposed subsidiary legislation will only apply
to shares of companies comprised in the Hang Seng Index or the H-Shares Index
and short positions in financial companies. In this regard, the Consultation Conclusions note that Hang
Seng Index and H-Share Index constituents comprised at the end of 2009
approximately 70 per cent. of the SEHK's market capitalization. However,
the constituents of the Hang Seng Index and H-Share Index represent less than 10 per cent. of all
companies listed on the SEHK, there being about 1,145 companies listed on the
SEHK at the end of 2009.
At the same time, the proposed subsidiary
legislation will only apply to short positions in the physically settled cash
market in Hong Kong. It is unknown the extent to which short positions are currently held synthetically or
otherwise off the SEHK. The limited application of the proposed subsidiary legislation contrasts with
recommendations in other jurisdictions to include derivatives within a short
position reporting regime.
It is unclear to what extent the new subsidiary
legislation would achieve its goal of increased transparency due to the ability
to take short positions through derivatives and the exclusion of the majority
of the stocks traded on the SEHK.
Drawbacks of New Proposals
The administrative burden of increased transparency
is high. As noted above, the SFC proposes to trigger short position reporting obligations under the new proposed
subsidiary legislation where a short position in a company exceeds 0.02% of the
issued share capital of the company or HK$30 million in value.
The 0.02% threshold is much lower than the
thresholds suggested by various organizations representing the investment banks
and alternative investment funds and is much lower than the threshold recommended in Europe. The SFC takes the view that this figure
is appropriate given the exclusion of derivatives from the short position
reporting regime and the specific characteristics of the Hong Kong market.
Unclear Need for Short Position Transparency
Whilst there is a clear international trend towards
short position reporting, the SFC cites no evidence of any need for a short
position reporting regime. The original consultation suggests that the regime will provide early warning of
large short positions that may be potentially disruptive to the orderly
functioning and stability of markets, improve insight into market dynamics,
deter abusive short selling behaviour and provide evidence that may aid
post-event enforcement action.
In this regard, it is significant to note that Hong
Kong already has substantial tools in place to regulate short selling. In addition to the transparency
measures described above, Hong Kong currently prohibits naked short selling on
the SEHK, requires an audit trail that short sales are covered, requires short
sales on the SEHK to be made at the current best asking price or better and
limits short sales on the SEHK to designated securities.
At the same time, under current law, Hong Kong has
an ample arsenal to investigate short selling. The SFC has extensive statutory investigation powers that
over-ride the privilege of self-incrimination and enable the SFC to identify
buyers and sellers in any given share or derivative traded on the SEHK over a
period of time and the extent of their long or short position at any given
time. In the event that buyers and sellers are located beyond the territorial jurisdiction of Hong Kong, the SFC
has long required licensed and registered brokers, who are within the
territorial jurisdiction of Hong Kong, to have in place contractual
arrangements with their clients which enable the SFC to identify the person
ultimately responsible for originating any order, including a short sale order,
and the person ultimately bearing the economic benefit or burden of any
order.
In parallel, the Hong Kong government through the Financial
Secretary has specific statutory powers to identify the persons who have short
positions in companies listed on the SEHK, whether through shares or
derivatives.
There is no real suggestion that the current
regulatory framework was in any way proven inadequate in the recent financial
crisis.
Unclear Need for Separate Parallel Regime
The Consultation Conclusions do not discuss why the
SFC seeks to establish a new parallel short position reporting regime outside
of the current law. It is no doubt true that there would be costs in modifying information technology systems
designed to accommodate Hong Kong's complex disclosure of interest regime. However, to the extent that the current position reporting regime may be
regarded as inadequate, it may be desirable to modify the regime so that it is
adequate and simpler to understand rather than to leave it in place and
supplement it with another regime which may add further complexity to an
already highly complex situation.
IMMEDIATE FUTURE
The SFC has yet to introduce subsidiary
legislation. Market participants concerned about the new proposals may still take steps to voice these
concerns. In particular, whilst the SFC has the power under existing securities laws to introduce subsidiary
legislation to implement its short position reporting regime, such subsidiary
legislation is subject to negative vetting by the Legislative Council. As a result, the Legislative Council
may modify the subsidiary legislation as it deems fit.
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