Could have been worse, say lawyers of Hong Kong shorting rules

Hong Kong's stock market regulator, the Securities and Futures Commission, conducted a survey in 2009 that has led it to change the monitoring of short selling in constituent stocks of the Hang Seng Index, H-shares index and certain other stocks, including financials.

The SFC only got 21 replies to its survey, but in an attempt to improve the picture of short selling activity, it has introduced a new rule whereby the SFC has to be informed on a weekly basis if a short position is equal to or exceeds 0.02% of the issued share capital of a listed company (in other words not a high threshold), or a market value of $30 million, whichever is lower. The reporting has to be repeated until positions fall back below the trigger levels.

"It was expected but I think the level of 0.02% is a surprise," says Rolfe Hayden, partner at law firm Simmons & Simmons in Hong Kong. "The exclusion of derivatives will be welcomed. It is important in that it is the first 'tightening' here and this is an international initiative affecting Hong Kong. It is, however, a muted conclusion; it could have been worse."

The weekly list will be an object of interest by virtue of the bearish views it presents. However, the identity of the firm owning the short position will be kept secret.

"Note that this legislation deals with reporting of positions but not the method or manner of short selling securities as Hong Kong already has a robust short-selling regime which the SFC appears to feel comfortable with," says Sharon Hartline, a partner at law firm White & Case in Hong Kong.

"This is more of an attempt to enhance the system to ensure that the SFC has access to information when a crisis does occur or may be brewing. Some of the biggest concerns with the proposed increased reporting obligations for short sales were firstly the cost of complying with the same versus the benefit of such information to the regulator and its ability to appropriately utilise the massive amounts of information that could be generated by an overly broad reporting regime and secondly the confidentiality of short positions."

This new reporting duty may be the first of other moves into line with other equity markets.

"We assume this will be the first step in a longer process of aligning with other jurisdictions," says Duncan Smith a partner at Ogiers in Hong Kong. "The reporting of derivatives is excluded, for example, meaning the total short position is going to be unknown anyway. The move also only considers a limited range of stocks. By and large Hong Kong coped well with the crisis and is quite well placed to watch and learn from the steps taken elsewhere. Unfortunately, to do nothing would not be acceptable."

One lawyer (who prefered not to be named), thinks this might be a paper tiger exercise.

"I suspect it is a damp squid [sic]," he emailed AsianInvestor. "Hong Kong's short selling rules were always robust -- which is why Hong Kong did not ban it when everyone else was doing so, and the fact that Hong Kong did anything is, I think, more a reaction that they want to be seen to be doing something when everyone else is."

During the financial crisis, Hong Kong kept its composure and its ability to short stocks when some others, who should have known better, didn't.