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Client Update: Capital Markets – 22 September 2008

Australian regulators prohibit 'naked' and 'covered' short selling

In brief: In response to recent global market conditions and arrangements put in place by overseas regulators, the Australian Securities Exchange and the Australian Securities and Investments Commission have announced measures to prevent short selling in Australia, which take effect from today. Partner Warwick Painter (view CV) and Senior Associate Justine Woodford outline the details.

On 19 September 2008, in response to measures being adopted by financial markets regulators in the United Kingdom, the United States and other jurisdictions, the Australian Securities Exchange (ASX) and the Australian Securities and Investments Commissions (ASIC) announced a package of interim measures to prevent 'naked' short selling in financial products1 in Australia. As part of that package, ASIC released Regulatory Guide 196, Short Selling: An Overview of section 1020B (RG 196) to clarify the current regulation of short selling in Australia under section 1020B of the Corporations Act 2001 (Cth)2.

The announcements were welcomed by the Federal Government. More significantly, on 21 September, ASIC went even further and announced that it was also banning all 'covered' short selling where the seller relies on a securities lending arrangement to cover the sale, with exceptions for market makers and warrant market makers hedging derivative positions. The provisions are intended to remain in place until the Federal Government passes into law its new short selling legislation (ie the proposed Corporations Amendment (Short Selling) Bill 2008).

The result is that, with limited exceptions (eg bona fide arbitrage transactions and market makers), ASIC has, for the present, effectively closed the door on short selling of ASX-listed securities. The prohibition on short selling came into effect from the opening of the Australian stock market at 10am today. The status of other 'covered' short sales under true purchase arrangements that do not involve securities lending (and which still appear to be permitted under an exception to s1020B of the Corporations Act) is unclear.

Further to the above developments, ASIC this morning asked the ASX to notify market participants that it will provide a 'no action' letter (to be issued later today) for hedging of existing positions of market makers arising from their client business. The letter will confirm that:

... prohibitions on covered short sales will not apply to hedging a position that was taken by an entity prior to 22 September 2008 as part of its business of dealing as principal in equities, options or derivatives (whether OTC or exchange-traded) to fulfil orders received from clients or to respond to a client's request to trade, in each case before that date.

We will keep you updated on further developments in this area, particularly in relation to the introduction of the Federal Government's proposed legislative reforms. The latest announcement by the Federal Government is that it will be shortly introducing into Parliament the legislation to strengthen disclosure of covered short-selling. It is not clear whether this legislation will also operate to limit the circumstances in which short selling is permitted.

Footnotes
  1. In general terms, this refers to securities, managed investment products and other financial products under section 1020B of the Corporations Act 2001 (Cth). Refer to RG 196 for further details.
  2. In RG 196, ASIC states that a 'naked' short sale occurs unless the seller has 'a presently exercisable and unconditional right to vest'. According to ASIC, this means a legally binding commitment is required from another party, such as a stock lender, before the sale is entered into. ASIC says that it will not accept an informal promise to locate stock before settlement day as sufficient for this purpose. Day traders, for example, will need stock to sell, before any sale.

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