Fig-leaf costs increase for naked short sellers
Him what sells what isn't his'n Must buy it back or go to prison This doggerel was coined in New York to describe stock-market punters who sold short without borrowing the stock for their short positions, then found they could not cover their shorts. Something similar is happening in Hong Kong.
Settlement of the $79 billion of turnover on the stock market on Friday was due yesterday; reports have surfaced that several of the biggest sellers on Friday have not been able to deliver the stock.
There are two rules to remember. First, any member of the stock exchange who sells short, for his own account or for a client, must notify the exchange it was a short sale. This rule has been breached more than observed.
Foreigners in particular have found it easy to evade the requirement by keeping the relevant records offshore, where the Hong Kong authorities cannot check on compliance.
If it now turns out that the trades cannot be settled, there will be clear evidence of selling in breach of this rule alone, and this when the authorities are minded to take a tough stance on manipulation of Hong Kong's markets.
The second rule, and possibly the more important one at this point, is that short sales are only allowed if the seller has borrowed the stock he has shorted, so he at least has some title to it.
Many investment funds find it profitable to set up stock-lending programmes for this purpose: a big fund manager who is a long-term holder of, say, five million shares of Hutchison can make extra money from them by lending them for a fee to other investors he thinks reputable and who wish to short the stock.
The indications are now that an unknown number of sellers last week were holding naked short positions. That is, they sold short without borrowing stock, which is illegal, and they counted on being able to cover their positions with stock lenders before anyone could notice.
Three things have made it difficult for them to do so.
First is that many of the normal stock lenders took advantage of the Government buying last week to sell down their Hong Kong holdings and no longer have the stock to offer to short sellers. Financial Secretary Donald Tsang Yam-kuen cornered the market.
Second is that trustees of some of these funds have apparently had second thoughts about stock-lending programmes.
They have a fiduciary duty to the holders of these funds, people like you and me, and it is not well carried out if they take in 3 per cent on stock-lending fees from speculators that use the borrowed stock to drive the value of their funds down by 30 per cent.
The third reason is that some local brokers who in the past have lent stock lodged with them by their clients and who never obtained their clients' permission - a truly shady practice if ever there was one - have been much more reluctant to do it recently.
Both the stock exchange and the Securities and Futures Commission have been tracking them closely over the past few months following some brokerage collapses earlier this year. They simply can't get away with it any longer.
As a result, some of the naked short sellers have been scrambling to cover themselves. At least one was bidding 16 per cent for three months plus a premium to borrow stock yesterday and there were reports of even higher rates.
They are being squeezed, as Mr Tsang threatened to squeeze them last week.
The big day to wait for now is Friday. Settlement is required within two trading days of a transaction and there is then a three-day grace period before the clearing system goes to the market to buy in unsettled positions.
The scramble to beat this deadline on last Friday's purchases will exert upward pressure on the market for the rest of this week.
But this time the Government is also likely to take some legal action against players who have broken the law. There are interesting times still to come.