Luke Simpkins (Cowan, Liberal Party) Share this | Hansard source

Sometimes some of the economic terminology that is used in this place is not well understood by everyone present. I am sure it is by most but possibly not by all. I strongly suspect that, with regard to this Corporations Amendment (Short Selling) Bill 2008, such a lack of understanding would be quite common. It is not something that everyone wants to tackle, but I welcome the opportunity to speak on this legislation today.

I will begin with an explanation of what it is all about. It starts with selling long, or buying shares at one price, with the expectation that they will go up in price and then you can sell them at a profit. Short selling is the expectation that a stock will fall in price. But where it gets different is when the stock is sold before the seller actually owns the stock. Thinking the price will fall, the short seller sells the stock with something like a three-day settlement date, at which point the handover of the stock occurs. In this way the seller does not actually need to have the stock for three days, giving the stock time to fall and a profit to be made, as well as time for the stock to be acquired and handed over.

There are two types of short selling, one type being naked or uncovered short selling and the other being covered short selling. Naked short selling is where the seller makes the sale transaction without an existing arrangement being in place to acquire the stock for the subsequent handover to the buyer. Often a naked short seller wants a three-day settlement for his sale but a same-day settlement for his buy. Covered short selling obviously still does not require the ownership of the stock that has been sold, but it has to have an arrangement already in place whereby the seller has access to the same type of stock. Such an arrangement normally involves a lender of stock, who will lend the short seller the stock so that the settlement can be made. The short seller then acquires replacement stock to give back to the lender. Covered short selling therefore ensures that stock will be available to be settled on the settlement day.

That brings me to the reason why short selling has attracted quite a bit of interest. It is because investors do not have confidence in the efficiency and the fairness of the market in spite of the fact that regulations regarding short selling are more stringent here than in other nations. Clearly, in the current environment greater transparency is desired with regard to short selling. Investors, and in fact the whole sector, require confidence in the integrity of their markets, otherwise prices, investment, risk management and, as we have seen, the provision of capital finance, will all be at risk.

Yet if we consider why short selling is such a risk, it is because, if there is a strong interest in short selling and that becomes known, there can be a lack of confidence in the company as other traders become panicked about price falls. There are scenarios where such a lack of confidence can be created by manipulation or abuse, even abuse of information, rather than access to a transparent set of figures. Yet transparency requires the collection of market data beginning, firstly, with the identification of that data. It is always wise to learn from the current rules within Australia and the overseas experience regarding short selling to, in effect, provide a stark point for a future direction.

With regard to transparency, this does raise a very interesting point. The commentary on this bill states that disclosure of covered short selling will indicate that some stocks may be overvalued and it will effectively give confidence to the investors, the buyers, to buy in the market as they will not be uncertain about what is behind the short selling, and of course market abuse can then be reduced.

I might also note that business commentator Terry McCrann in the Herald Sun on 21 November this year described covered short selling as not actually being short selling. He said that, effectively, the borrowing of shares involves the transfer of the full legal title to the seller. The seller then in fact becomes the owner of the shares, which until the tax act was changed in 1989 would have represented a realisation. Mr McCrann suggested that covered short selling would stop if the tax act was changed and tax made payable on the loaned shares, which seems to be an interesting point.

I will speak about the exposure draft and industry perspectives. However, before I do that I just want to go through the coalition’s position on the bill. With regard to schedule 1—again, as I am sure others have said—we support the implementation of schedule 1 as a measure to enhance market transparency by providing certainty to both ASIC and industry regarding the scope of ASIC’s powers. With regard to schedule 2, again we support its implementation because we believe financial transactions like naked short selling can distort the operation of financial markets by causing increased price volatility. As I have previously said, it is right that naked short selling can facilitate a market manipulation and can damage confidence even though naked short selling is estimated to represent less than two per cent of all short sales.

The coalition does not support schedule 3, because as you look through the text of the bill the amendments are not much more than a straw man of ‘ifs’ and ‘mays’ with regard to yet-to-be-announced or possibly not-yet-thought-of regulations, a straw man waiting to be filled out with regulations at the future whim of this government seeking to bypass the scrutiny of the parliament. I ask the question: why, after such consultation as stated by the government, are there no details for this schedule? I do not see how the cause of stability is furthered by this schedule which purports to deal with the disclosure of covered short selling.

I would next like to turn my attention to the government’s exposure draft and the options put forward for dealing with short selling, and I will speak on these in detail. Option 1—retaining the status quo or taking no regulatory action—involves retaining the current regulatory arrangements and encouraging voluntary disclosure of covered short sales. This means no additional regulatory costs for businesses but also no change in the level of uncertainty in the market caused by covered short-selling activity. Clearly, investors would see no reason to disclose information to the market and the government would have no additional means to make it happen.

As for option 2, the one the government wants—disclosure of covered short sales to brokers—the commentary on the exposure draft states that this option places an obligation on investors to disclose covered short sale transactions to their broker. The broker must then report on to the market operator. It is here that we on this side begin to have a divergence from the government. A general disclosure obligation and penalties are fine in the Corporations Act, but what we have in the bill are airy-fairy references to regulations which are not yet available. Yes, there is technical detail involved, but this is too loose for my liking and that is why we oppose schedule 3. It is also noteworthy that in the commentary mention is made of the need to specify the technical aspects of the disclosure requirement in regulations so as to provide sufficient flexibility so the requirements can be amended to take account of any changes in market activity in the future. That is quite right, but let us have those regulations and a schedule that accurately reflects the detail.

Option 3 is described as the direct disclosure of covered short sales to the market operator. This option requires a clear and direct obligation on investors to disclose covered short sale transactions to the market operator. As discussed before under option 2, this requirement would be implemented through the Corporations Act, and schedule 3 and lack of regulations equally undermine this option. What can be said for this option is that it would be cheaper in terms of regulatory costs than option 2—cheaper for investors but a significant problem for the market operator who would endure the significant regulatory burden. Investors would nevertheless be required to make significant changes to their processes and their systems to allow the reporting of this information directly to the operator. These would be in addition to the costs for investors identified under option 2 in relation to determining their exposure on particular securities. Investors would have the benefit of confidentiality as the brokers would not see the individual trades. It is, however, expected that the overall costs incurred by investors and the market operator under option 3 would in fact be greater than the costs incurred by brokers under option 2.

With regard to option 4, which is the disclosure of stock-lending transactions, this involves the obligatory disclosure of all stock-lending transactions because it would equate directly to the level of covered short-selling activity in a particular security. Similar to options 2 and 3, this option could be implemented through the Corporations Act supported by supplementary regulations and therefore suffer from the limitations we have already identified. It is worth noting that some stakeholders have questioned whether stock-lending data will provide a sufficient indication of short-selling activity—and I will go on with that later. Under those circumstances the disclosure of stock lending alone is therefore of limited value.

Finally, option 5 is a review of the existing short-selling regime—which I would have thought the government would have been attracted to given the word ‘review’ is involved. As the commentary says, this option involves a wholesale review of the regulatory framework governing all short-selling transactions. This review would cover the existing rules relating to short sales in the Corporations Act. Given the submissions taken by the government on this bill and short selling in general, this should pretty much have been achieved or at least the relevant information should have been made available already. It is obvious that option 2 has been adopted by the government. This option places an obligation on investors to disclose covered short sale transactions to their brokers. The broker will then be responsible for reporting this information to the relevant entity, the market operator.

Of course, those in the markets have another view and that is worth listening to. I am aware that AFMA, the Australian Financial Markets Association, offered two of their own proposals. Proposal A involves disclosure of all short sale positions, or a direct method. They acknowledge that one of the greatest challenges in collecting functional data on short selling is the task of producing consistent data from all market participants on their short-selling activities. AFMA is of the belief that the only way to overcome this is to collect information directly from entities that hold short sale positions. This would involve fund managers, who could report though custodians and retail clients through their Clearing House Electronic Subregister System, or CHESS, sponsors. I am informed that brokers currently report their own short sale positions to the stock exchange on a daily basis but that they do not have the information necessary to report their client positions. Similarly, it is very hard to imagine some clients wanting that information provided. However, fund managers have signalled their willingness to disclose to the market regulator on a bimonthly basis their aggregate short-selling positions on a stock-by-stock basis. I have made mention of this in a previous speech.

This overcomes the main problem identified in the commentary in relation to option 3. Many in the markets support such a proposal, as it would produce the most meaningful and reliable aggregate data on short sale positions in individual stocks. It represents data that the market would find valuable and useful. The advantage is that it would be easier for a wide range of investors to interpret. It would also provide listed companies with a clear and very interesting insight into the build-up of short sale positions in their stock. This is not possible to achieve by using just transaction data. But a public release of information in such a manner reduces the risk of increased price pressure or volatility and preserves confidentiality of strategic trading positions. It is also agreed that disclosure of substantial positions—of five per cent of the underlying stock—is relevant to the policy objectives. I would certainly advocate for the need for entities to register with the Australian stock exchange or ASIC as an entity eligible to short sell in the Australian market, requiring effective compliance.

I should say that AFMA makes the point that the UK Financial Services Authority now requires short sellers to disclose net short positions of more than 0.25 per cent in financial stocks. The US Securities and Exchange Commission also moved recently to require disclosure by institutional investors of the number and value of each stock sold. It is correct for investors to focus primarily on the fundamentals of companies when making investment decisions, rather than on the level of shorts in the market. I think we can all agree on that. However, if this is relevant to the assessment of the underlying value then information on the level of short sale positions rather than the transactions is in fact the easiest information to interpret.

What I have described is one AFMA proposal, yet they also have an alternative—an indirect method—which involves disclosure by the Australian stock exchange of transactions that are the subject of borrowing arrangements in the market. It is suggested that securities that are lent could be the subject of coding in CHESS so that a percentage of borrowed stock can be identified as part of the total stock. They believe that this is a very good method of getting the data for onshore and offshore stock borrowings.

It would appear that the markets believe that both the above proposals are superior to the direct disclosure of covered short sales to brokers, as proposed in option 2 of the commentary. A key concern in this regard is the low value that traders attach to the information that would be collected under option 2. Transactional data is not as relevant as position data, as no observer of individual transactions can make a judgement as to the size of the open short positions in the market. There are also a variety of practical and operational problems encountered in complying with a real time tagging regime, which give rise to significant concerns about the consistency and reliability of the data in terms of the objectives of transparency. Option 2 data would not capture intraday closeouts, would be volatile over time and would not cover the purpose of short sales reported. Data quality would be reliant on clients reporting all of their short sales to their broker. Traders may not be able to advise if a particular sale is a covered short sale at the time of the order placement because they would have incomplete knowledge of the entity’s total position or how sales are intended to be settled. For instance, some traders rely on daily stock availability sheets provided by their equity finance desks to support their trading activities. The trader may not know whether the stock availability is sourced from existing inventory, borrowed stock or stock lent that can be recalled et cetera. This may lead to overreporting in some instances.

Further, when aggregating several orders together, some of which may be short and some of which may not be, tagging the order will not give accurate information to the market on the level of short selling. In addition, members have noted the need to balance transparency against possible market liquidity impacts, especially the willingness of traders and market makers to offer liquidity under these conditions, when assessing the benefit from the real time tagging of orders. There is a risk of greater market volatility. Another key concern of AFMA and the markets is that option 2 would require significant systems changes and would therefore be expensive to implement. They give an example. Direct market access systems would have to be reconfigured to capture covered short sale trades, as clients are prohibited from naked short selling but trading pursuant to a borrowing agreement may be permitted. I certainly appreciate the information I have acquired from AFMA to inform my comments today.

I will close by speaking of the problem we have with this bill—schedule 3. The third schedule is about trying to provide a legislative base to regulate covered short selling. Yet there is insufficient detail on disclosure provisions, and we know there is industry concern about how they would work in practice. We believe that schedule 3 is an unknown quantity and is just a shell to be fleshed out with a circumvention of the parliament, because all the important detail will be outlined in the regulations.

It would certainly appear to be the case that there is a complete lack of detail in relation to how the disclosure requirements will work. The key issues and concerns of the industry remain unresolved. I say that these matters should be resolved now and dealt with to get it right in the first place. The information is available and the stakeholders have made sensible and realistic contributions. They should not be disregarded—not if the government wants to achieve the desired results. The question should be: why has all this consultation time been wasted with this ineffective and inept schedule 3?

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