City shocked by FSA plan to crack down on short selling

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The Independent Online

The Financial Services Authority stunned the City yesterday, demanding that investors disclose significant short positions in companies during rights issues in an attempt to stamp out market abuses.

The FSA said it would require investors to disclose short positions of more than 0.25 per cent of shares in issue on companies conducting rights issues, starting on 20 June. The move was seen as an emergency measure to support banks' rights issues after their shares were battered by speculation.

HBOS's shares fell below the bank's rights price of 275p on Wednesday, causing fears that the underwriters could be left holding the stock from its £4bn issue. Royal Bank of Scotland, which completed its £12bn cash call on Monday, and Bradford & Bingley, which is raising £258m, have also faced intense pressure. The FSA has been pressing banks battered by the credit crunch to boost their capital positions but the pressure on share prices has threatened announced issues and could deter others from following. Companies such as housebuilders may also need to raise capital as the economy slows down.

Rights issues are drawn-out processes that leave the issuer's stock vulnerable to volatility and manipulation. Investors, armed with the terms of the rights issue, can borrow and then sell stock they do not own to drive the shares below the rights price in the time before the rights are taken up. Once this has happened, confidence in the issue rarely recovers.

Banks have been particularly vulnerable to speculation because of the widespread uncertainty about their financial positions and a barrage of gloomy news on the economy. HBOS's shares fell 17 per cent in half an hour in March, prompting an FSA investigation.

Nevertheless, many in the City were shocked by the draconian nature of the move by the FSA, which has also threatened to curb severely the stock-lending practices that underpin short selling.

"It smacks of a knee-jerk reaction to the problems that the current UK bank rights issues are going through," said Darren Fox, a partner in the financial services group at the law firm Simmons & Simmons. "There is consternation in the buy and sell side about this."

The FSA said short selling was a legitimate investment practice but that the rights issue process provided more opportunities for abuse. The regulator would normally consult at length on a major rule change but said it was reacting to unacceptable levels of share-price volatility and potential abuse.

Alan Yarrow, the chairman of the London Investment Banking Association, said: "The FSA is clearly focused on improving the transparency of share transactions during rights issues and is taking particular steps to improve the balance of information about share transactions. As a financial centre we have to be efficient in raising primary capital. That is the main driver here."

Though it suspects abuse, the FSA is not launching an investigation into shorting during rights issues, effectively imposing an amnesty that gives investors a week to clear their positions.

David Rule, the chief executive of the International Securities Lending Association, said the proposed restriction on lending shares was a big concern. "That will damage the whole equity market because dealers won't be able to hedge themselves and settlement will become more difficult." The ISLA said it did not object to disclosure requirements but warned there is a mismatch between the size of short positions that must be revealed and the rule that only long holdings of 3 per cent or more have to be declared.

Shares in companies doing rights issues or expected to announce them surged as short positions were closed and the threat of volatility reduced. HBOS jumped 13.7 per cent to 321.75p with Alliance & Leicester gaining 11 per cent and Bradford & Bingley up nearly 9 per cent.

Johnston Press, whose shares fell below its rights price along with HBOS on Wednesday, surged more than 20 per cent. Barratt and Persimmon, housebuilders that may need more capital, both rose 10 per cent.

The FSA said it had consulted market participants such as banks and lawyers. It is understood that several investors indicated they would refuse to reveal their holdings voluntarily, prompting the FSA to lay down the law.

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