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Proposed EU Short Selling Disclosure Regulations Bad for Large HF Groups and the Market
Simon Kerr
Simon Kerr's Hedge Fund Blog
Dec 2010

Proposed short selling disclosure regulations announced recently by the European Commission (EC) are too stringent and threaten market efficiency in a general sense. Specifically, implementation of the regulations as currently drafted would be very damaging for larger hedge fund groups.

Shorting and Market Efficiency

Hedge funds, along with proprietary trading capital, dominate the shorting of shares. Day traders and individual punters short shares in the United States, but most shorting is carried out by hedge funds. A number of studies have demonstrated that the ability to sell short contributes to the accurate and efficient evaluation of financial instruments. For example, the paper "The Importance of Short Selling", published in September 2009 by the Asia Securities Industry & Financial Markets Association makes the case: In markets with bans on short selling, market participants with negative information that do not hold inventory of securities will be constrained from selling and their information will not be fully reflected in the prices of the instruments. Further restrictions on short selling can, in this way, increase the magnitude of overpricing and subsequent corrections or reduce the speed of price adjustment to private information, according to this and other research. So impediments to short selling can impact market efficiency.

Disclosure to the Regulators

The newly created European Securities and Markets Authority will have the power to temporarily ban short selling altogether. It is proposed that investors will need to disclose short positions to regulators if they exceed 0.2% of a company’s issued share capital and to the rest of the market if the short position exceeds 0.5%. The proposed regulations would also require that short selling of government debt be disclosed.

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