A few years ago, a trader for an investment bank was quoted in a London newspaper offering the most brazen of excuses for insider trading.
'Inside information?' he was quoted as saying. 'No way. We were just playing our position on the knowledge curve.' Welcome to one of Hong Kong's favourite curves.
The rules covering short selling on the stock exchange are explicit. Only designated securities may be sold short and any member of the exchange selling short either for his own account or on behalf of a client has an obligation to ensure when placing a short sales order that the short-sold security is available for settlement.
The rules also state that a member must indicate every short-selling transaction when inputting the short-sell order, state that it is a short sell on the contract note and maintain an up-to-date ledger for the authorities.
Ask your stockbroker, and he'll tell you that the rules apply only to short sales he has made himself. You can confidently count on the fingers of one hand the number of brokers who recognise that the rules say '. . . or on behalf of a client . . '. They haven't read the rules.
Amputate a few fingers and you'll still be able to count the number of brokers who ask their clients whether a sell order represents a short sale. They don't dare. Clients treat it as effrontery.
In its Financial Markets Review published in April, the Hong Kong Monetary Authority (HKMA) admitted: 'The SEHK [Stock Exchange of Hong Kong] understands from market practitioners that unreported short selling of Hong Kong stocks based on offshore borrowing exists both in Hong Kong or overseas. The extent of such practice is, however, unknown.' Yet, in the preceding paragraph, the review states 'the aggregate value of short-selling transactions remained insignificant as compared to the total trading in the stock market.' The HKMA came to this conclusion because it took the reported short position as being all there was, although admitting on the same page of the review that it was very likely not.
Take just one example the review cites. Last October 23, the Hang Seng Index declined by 1,211 points on a turnover of $34 billion, and the reported short sales amounted to only 0.4 per cent of this total, or $136 million.
There were reported short sales on only 25 stocks of the more than 300 designated as eligible for short selling, and these 25 did not include some of the biggest in the market.
It is difficult to dispute figures on individual stocks, but the overall picture appears blatantly false. I was an investment strategist at the time, and that month spent two weeks visiting clients in the United States, many of whom told me they had taken or were taking short positions in Hong Kong. These were big-money players.
The experience of 17 years of stockbroking in Hong Kong and some first-hand acquaintance with how hedge funds operate tell me it is a ludicrous notion that only four tenths of one per cent of the turnover on October 23 represented short sales. It simply cannot have been so. The real figure had to be much, much higher.
And this is where the knowledge curve comes in. The New York investment banks run a more efficient and less costly service in stock borrowing and lending than is available in Hong Kong. The HKMA admits it.
These are the players with whom the big short positions are placed, and they are consequently much higher up the knowledge curve than you or me. They have an open book available to them on which way the market will move. It's called their trading book.
They know exactly when the short position on the stock market has grown so large that they can safely go long the futures or when it's time to short the futures because of changes in their cash book.
But let's get this straight. They know it and we do not because they are in breach of Hong Kong's rules requiring full disclosure of client short positions. They can get away with it because it's all done offshore. We in Hong Kong have shot ourselves in the foot on this one. How long can the HKMA insist that it doesn't hurt?