FSA proposes greater disclosure re short selling

"The practice of short selling has attracted a good deal of critical attention in the last few days. By short selling, I mean selling shares one does not own, and borrowing them to meet obligations to the purchaser.

The sharpest critics of this practice argue that it facilitates bear raids on stocks and thus contributes to downward pressures on equity prices, exaggerating market declines, or falls in particular stocks. Some would therefore like it banned outright. Others want the UK to follow some overseas markets in putting various forms of grit into the machine for example the so-called uptick rule used most notably in the US. Under this rule a short sale cannot be executed unless the previous price movement in the stock was an upward one. The most recent suggestion is for a type of Tobin tax on short sales. Other commentators, while seeing no requirement to introduce such market constraints, nevertheless are concerned about the current lack of transparency about the level of short selling.

To assess the validity of these arguments, it is worth looking at the empirical evidence. Hard and fast information about the volume of short selling in the UK is not available. However, CREST, the securities settlement system, has provided us with statistics about the volume of stock lending in the market. These figures provide a reasonable proxy for the level of short selling to go short of a share for any length of time you typically have to borrow the stock. The data we have from CREST show that levels of stock lending recently, when the markets have been falling fast, have not increased significantly compared to earlier in the year when the FTSE was trading fairly stably in the 5,000 to 5,300 range. Stock lending has continued to represent around two per cent of total FTSE 100 stock. Nor do our contacts with the major equity market traders indicate any upsurge in the volume of short selling over the last few weeks.

Even if there had been, it is not clear that one could link this causally to the decline in share prices. One recent published analysis could find no statistical link between changes in stock loan levels and share prices for FTSE 100 stocks. (I should in fairness note that the same study did find a link between large changes in lending for mid-sized firms and their prices. But mid-sized firms have not fallen any faster than FTSE 100 stocks during 2002).

Some argue that there may have been an increase in intra-day short selling, which may not be picked up in these figures. But it is hard to see how intra-day trading could have a significant impact on prices over a period. And some of the sharpest price falls have occurred at the end of trading, at a time when intra-day short sellers would be closing their positions.

I should make it clear, therefore, that we see no case for any outright ban on short selling, a practice which we judge a necessary and desirable underpinning to the liquidity of the London market. No major market has taken such a step.

But what of the case for other constraints, short of an outright ban? Here it is worth comparing UK experience with that of markets which do place constraints on short selling. Over the last three months the US S&P500 and the French CAC40 indices have fallen at least as far as the FTSE 100, as has the German DAX index. We can see no obvious argument that introducing an uptick rule would necessarily reduce volatility or raise prices.

However, this is not to argue that UK practice must be left exactly as it is. One of the options we are examining is what can be done to make available to the market up-to-date information on volumes of short selling or at least of stock lending as a proxy for this. It is important to identify what would be of value to the market, how it could be supplied cost-effectively and how to avoid intruding into commercial confidentiality. But, subject to those caveats, we are sympathetic to arguments for greater disclosure. Markets rarely suffer from regulation that improves the flow of information.

Any changes would have to be subject to a consultation process; and a decision to change would also have to allow adequate time for firms to make any necessary IT amendments to their reporting systems. But we will bring forward proposals in early October."

Notes for editors

1. Howard Davies was speaking at the Commonwealth Games Business Breakfast at the Bridgewater Hall in Manchester, held by the Commonwealth Games Business Club.

2. The FSA is also planning to convene in September a Roundtable of market practitioners and trade associations - including critics of short selling, as well as hedge funds and prime brokers - to share views on the practice.

3. A Tobin tax refers to a small tax on foreign exchange transactions, originally proposed by the economist James Tobin to discourage speculative trading.

4. The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000; maintaining market confidence; promoting public understanding of the financial system; securing the appropriate degree of protection of consumers; and fighting financial crime.

5. The FSA aims to maintain efficient, orderly and clean financial markets and help retail consumers achieve a fair deal.