Short-selling costs double as investors are drawn to new strategy

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The parlous state of the equity markets on both sides of the Atlantic has sent investors piling into the controversial practice of shorting, which has driven fees to more than double in just nine months.

The price of borrowing stock in London's blue-chip companies has risen twofold since last October, according to Data Explorers, which specialises in stock-lending information, and went up as much as four times in January.

The data group added that the cost of borrowing stocks from mid-tier companies on the FTSE 250 has trebled in the past 10 months, although it did not release the actual size of the fees. In the UK, banks and housebuilders have been particular targets of the short sellers this year.

William Duff Gordon, the managing director of Data Explorers, said: "There is a finite amount of stocks to be shorted out there, and they have become increasingly in demand as the market conditions have weakened." The company found that stock lending had also trebled in Spain and doubled on the S&P 500 in the US.

David Rule, the chief executive of the International Securities Lending Association, the industry body that represents stock lenders, said the price would have moved purely because "stock lending commissions are based on supply and demand."

Pension funds and insurance companies can make money on their long-term share holdings by lending them, for a fee, to a hedge fund or proprietary trader at an investment bank.

The trader makes money on the stock by immediately selling the shares into the open market. After a predetermined time, the trader will buy the shares back to return to the lender. If the price has fallen in the meantime, they pocket the difference.

The category of shorting is split between general collateral, which tends to be lent out at a relatively low commission, and special, which is a stock in particular demand and tends to be lent at a higher fee. Northern Rock was heavily shorted before it was nationalised, while almost 20 per cent of Bradford & Bingley stock is currently out on loan.

There is no marketplace for stock borrowing. The fees are negotiated between the traders' custodians and the funds that own the underlying asset. "Institutions reserve the right to charge more if the stock is in demand," Mr Duff Gordon said.

Another reason for the rising fees is the number of participants using stock lending as a strategy. Mr Duff Gordon said: "Trading used to be about long-only trading, but now with the rise of hedge funds and proprietary traders the competition for lending has grown hugely."

This comes weeks after the Financial Services Authority established a new rule designed to lift the veil on investors shorting companies carrying out rights issues. On the day the rule came into force, hedge funds including Harbinger Capital and Lansdowne Partners emerged as holding significant short positions in HBOS.