Hong Kong’s current short selling regulatory framework embodies the principle of transparency. Short sales executed on the Hong Kong Stock Exchange must be flagged; and aggregated covered short selling turnover is published daily. However, no information is available on the outstanding short position in the market at present. The proposed increased transparency will facilitate a better understanding of the overall dynamics of short-selling activities in Hong Kong and enable the SFC to better perform its regulatory functions.
The regulatory regime for short selling is built on high-level principles developed by the IOSCO Task Force on Short Selling, chaired by the SFC’s Chief Executive Officer Martin Wheatley. The principles are that short selling should be subject to an effective regime that reduces potential risks that could affect the orderly functioning of the markets and provides timely information to the market or to market authorities, while allowing for exceptions for transactions that contribute to efficient market functioning and development.
With increasing financial innovation, derivatives and other financial instruments can be used to create short exposures that have a similar effect to a short sale. Short position reporting that does not include derivatives would provide an incomplete and misleading picture of the short interest in the market. But the SFC also recognizes that including derivatives will make the disclosure more complicated even though it may be more complete.
There does not appear to be a uniform practice internationally on the inclusion of derivatives, noted the Commission. The UK takes an economic interest approach under which short positions that need to be disclosed include all instruments that give rise to an exposure to the issued share capital of the company. In the US, the SEC reporting requirements on certain institutional investment managers only cover certain specified equity securities. In Japan, the short position reporting requirements cover only equity stock short positions.
The main proposal of the SFC is to include single stock, basket and index derivatives unless they have been exempted by the Commission. The scope of this disclosure should give a fairly complete picture of the short positions. Financial products that do not create a direct exposure to the stock of a listed company, such as credit default swaps, will not be included in the reporting regime.
Since there does not appear to be an international uniform approach on how short position reporting requirements are triggered, the SFC is considering threshold and periodic approaches, as well as a blended flexible approach. In the UK, short position reporting is triggered when a person holds a certain percentage threshold of a listed company’s issued share capital. Under the periodic approach, US reporting requirements apply only to institutional investment managers that exercise discretion with respect to accounts holding certain classes of equity securities having a fair market value of at least US$100 million. Such investment managers are required to file weekly reports to the SEC unless the short position is less than 0.25% of the issued securities and the fair market value of the short position is less than US$1 million.
A third way being considered by the SFC would be to adopt less onerous reporting requirements, either a threshold or a periodic reporting approach, with flexibility for the SFC to tighten the requirements in contingency situations. Under the flexible approach, the SFC would be empowered to declare a contingency situation during which the reporting frequency will be increased (to daily reporting, at most) and thresholds may be tightened. When normal market conditions resume, the usual reporting requirements would be reactivated. The Commission envisions this as a practical approach that addresses the regulator’s need for timely and detailed information in a crisis without incurring disproportionate compliance burden during normal circumstances.
The frequency of reporting will depend on whether the threshold or periodic approach is adopted. If a threshold approach is adopted, in order for reporting to be effective it should be done as soon as practicable after each threshold level has been crossed. Here, the SFC suggested that reports should be done within the business day following the day on which the short position exceeding the threshold is created. If periodic reporting is adopted, persons holding short positions may be required to disclose to the SFC their positions as at the close of the last business day of the week within the first business day of the following week.
If short position reporting requirements are introduced, the SFC would impose the reporting obligation on holders of positions. Brokers or custodians may be permitted to report the information on behalf of holders, said the Commission, but the holder of the position would be held accountable for any failure of the agent to comply with the reporting requirements. The Commission reasoned that holders of positions are best placed to calculate their overall short position.
The SFC is wrestling with the contentious issue of whether the information should be reported privately to the regulator or disclosed publicly. A possible solution would be to require reporting on a private basis to the SFC and for the information to be disclosed publicly by the Commission on a delayed and aggregated basis without the identities of the holders of the short positions.