Short Selling: Assessing New Zealand’s regulatory regime and future development 1. Introduction
1.1 The recent global economic crisis has seen an unparallel shift in the global perception of free markets. Regulators around the world have adopted a more strict regulatory approach to markets than seen previously. Short selling is been given particular attention from authorities due to its speculative use and questionable moral nature. As in the past, “short selling has been a favourite whipping boy”. 1.2 This essay examines the current regulatory measures in place in New Zealand regarding short selling. This essay will also evaluate the policy arguments with reference to the United States of America’s regulations and the recent economic crisis. Furthermore, this essay will ultimately argue that minor adjustments to the current regulation are beneficial. But, overall, complex regulatory reform is unnecessary and would cause an overall negative effect on the whole market. 2. The purposes of short selling
2.1 Short selling is a relatively straight-forward concept. “An investor borrows a share of stock, from a broker, and sells it. Later, the short-seller must purchase a share of the same stock in order to replace the share that was borrowed...the short seller anticipates the stock price will fall, so that the share can be purchased later at a lower price than it initially sold for. There are two main forms of short selling: Conventional short selling and naked short selling. Conventional short selling is where the investor has the funds to cover their position. On the other hand, naked short selling is where the investor must borrow the funds to cover their position as mentioned above. 2.2 Investors who want to sell a stock short must, at least in case of conventional short selling, first find a party willing to lend the shares they intend to sell. Therefore, speaking of short selling, we also need to consider the structure of the equity lending market and other specific problems related to it.
2.3 Securities owners often allow their brokers or depositories to hold their securities on their behalf. Securities lenders holding securities on behalf of their clients legally own them, while their clients only hold corresponding interests in their accounts. Under a securities lending agreement, the title to the securities passes to the borrower of the securities and the short seller, respectively. In turn, the borrower gives a certain amount of the shares’ market price as cash collateral to the lender. While holding the collateral, the lender is able to reinvest the cash and make a return.
3. Current Regulation
3.1 The Securities Market (Market Manipulation) Regulations 2007 was enacted to prevent and restrict certain activity that manipulates markets. Regulation 20 holds that short selling is exempt from market manipulation provisions in section 11. The regulations make it clear that short selling and crossing of trades are not market manipulation for the purposes of the Act merely because they are short selling or crossing of trades, so long as they fall within the rules of a registered exchange. For practical purposes this means that these practices will not be market manipulation. The NZX is charged with regulating its own short selling. The regulations on short selling are outlined in the appendix: 4. Analysis
4.1 The regulatory measures are generally quite broad and limited attention is paid to specific circumstances in the market. Overall, short selling where there is a Takeover or an acquisition, is highly regulated. Additionally, the NZX has complete discretion to stop short selling. This provision of authority has rarely been used. Furthermore, they were not used during the latest slide in market prices. 4.2 All dealings in short selling must be made in “Good Broking Practice”. The definition provides no real detail, only that practices must “comply with the spirit and intent of the practices”. The...
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