Page last updated at 15:41 GMT, Friday, 13 June 2008 16:41 UK

FSA cracks down on short selling

Halifax sign outside a branch of the bank
HBOS shares have been volatile since its rights issue was announced

The UK's financial watchdog, the FSA, has turned its attention to "short selling", the stock trading technique blamed for an HBOS share price slump.

From next week, investors with "short" positions in firms offering new shares will have to declare their interest.

Short-selling occurs when an investor borrows company stock owned by another investor, then sells the shares in the market, hoping the price will fall.

They then buy the shares back at a lower price, pocketing the difference.

'Potentially damaging'

In recent days, HBOS shares have been under significant pressure.

Between Friday 6 June and Thursday 12 June, the stock lost more than 14% of its value. On Wednesday, the company's shares tumbled almost 12%.

Companies issue extra shares to raise money
They are offered to existing shareholders, usually at a discount to the current share price
Shares are offered in proportion to existing holdings, so if you own 10% of the old shares you are offered 10% of the new ones

Observers blamed aggressive short-selling by hedge funds ahead of HBOS's rights issue, which aims to raise 4bn and has priced the company's stock at 275 pence each.

On Wednesday, HBOS's share price dropped below the rights issue price, closing at 258p.

Following the FSA announcement, HBOS shares rose 13.6% to close at 321.75p.

The Financial Services Authority (FSA) said that short selling was responsible for "severe volatility in the shares of companies conducting rights issues".

"This is potentially damaging not only to the issuers in question but also to confidence in the overall fairness and quality of the UK market. It can be particularly prejudicial to the interests of small investors."

"The problem is compounded by the length of time taken to complete rights issues."

City experts said that short selling was now an established practice, with people doing it for a variety of different reasons.

"There is clearly quite a lot of short selling," Sir Michael Savory, a former chairman of HSBC Stockbroker Services, told the BBC.

He added that when banks' balance sheets were under pressure then there was an opportunity for institutional investors to short their positions.

"Many of the institutions are existing shareholders in these banks," he explained.

"What they are doing is protecting their existing investment by shorting."

'Assists liquidity'

HBOS is not alone in having to go to their shareholders and ask for more cash, with Royal Bank of Scotland, and Bradford & Bingley also tabling rights issues.

"In current market conditions, there is increased potential for market abuse through short selling during rights issues," the FSA said.

As a result, the FSA said it would introduce changes from Friday 20 June 2008, that will require "the disclosure of significant short positions in stocks admitted to trading on prescribed markets which are undertaking rights issues".

The argument is neither consistent nor a thought-through response to a perceived problem
Simon Morris
CMS Cameron McKenna

The FSA will define a significant short position "as 0.25% of the issued shares achieved via short selling or by any instruments giving rise to an equivalent economic interest".

"The obligation will be to disclose positions exceeding this threshold to the market by means of a Regulatory Information Service by 1530 the following business day," it explained.

The FSA said it would also look at whether further measures were needed.

Despite calling for greater disclosure from investors, the FSA emphasised that short selling was "a legitimate technique which assists liquidity" and was not abusive.

'Rules in place'

The FSA measures were "changing the geography of the market" without any consultation said city lawyer Simon Morris of CMS Cameron McKenna.

"In one sentence FSA says that short selling is a legitimate technique and in the next claims it could lead to market abuse.

"The argument is neither consistent nor a thought-through response to a perceived problem. If there are abuses taking place then there are rules already in place to deal with them."

He added that the need for disclosure meant that traders would have to be open about how they did business.

"The FSA might as well tell hedge fund managers and other investment managers to publish their strategies and place them on their websites."

Another expert said the effect of shorting shares could also be seen in the poor performance of house building firms, and that the general mood of the market and the difficulties of individual companies were also influential in how they did.

"You have to remember that the news has got significantly worse since the Bradford & Bingley profit warning," Edward Bonham-Carter, head of fund management firm Jupiter Asset Management.

"Shorters can only really work if the news is getting bad."

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