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5 things you need to know about … short selling

#1 Legal Adviser to Activists 

Bloomberg Activism League Tables, Europe & Asia, FY 2020

 

1. What is short selling and why is it controversial?

Short selling is the practice of betting that a listed company's share price will drop. This is typically effected by the person who is placing the bet (usually a hedge fund) borrowing shares which it then sells and subsequently buys back at a lower price in the future. The hedge fund will then return the shares that it borrowed to the lender and will pocket the difference between the price at which it sold and then bought the shares. Critics argue that speculating on a price drop is unethical and can destroy value for long-term investors. In times of market stress, regulators have introduced temporary short selling bans and/or market restrictions on short selling as a way to moderate falling share prices.

#1 Legal Adviser to Companies

Bloomberg Activism League Tables, Europe & Asia, FY 2020

 

2. How is short selling regulated in the UK?

In the UK, regulators have said there is no evidence to suggest that short selling has been a driver of market falls. Indeed the Financial Conduct Authority has emphasised the important role that short selling can have in properly functioning markets. Examples such as NMC in the UK and Wirecard in Germany have supported this thesis. However, short selling has come under increased scrutiny since the very public GameStop saga earlier in the year, which has already triggered a review by the Securities and Exchange Commission in the US. Following this, it is likely that regulatory bodies in other countries will be looking closely at what can be done to improve transparency in the market.

#1 Legal Adviser to UK quoted companies listed on the LSE

Adviser Rankings, US law firms, March 2021

 

3. Disclosure obligations in the UK

In the UK, a private notification to the FCA must be made when the net short position relating to shares reaches 0.1% of the issued share capital of the company, and again at each 0.1% above that. A public disclosure is triggered at 0.5% and each 0.1% above that. Public disclosures can be found on the FCA's website.

 

4. Targets for 2021?

There are record amounts of money chasing SPAC and ESG opportunities and we're already seeing SPACs and certain ESG-friendly companies being targeted by short sellers. Investors will be watching closely for SPAC founders rushing into unattractive deals in a saturated market and companies over-selling their ESG credentials. As regulators play catch-up to hold companies accountable for the ESG claims they make, short sellers will continue to target the pockets of overvaluation.

 

5. The Big Short

Based on the book by best-selling author, Michael Lewis (of Moneyball and The Blindside fame), the 2015 film, starring Christian Bale, Steve Carell, Ryan Gosling and Brad Pitt, tracks the lives of several financial-industry professionals in the mid-2000s as they predict the collapse of the housing bubble. Based on true life stories, these individuals made millions by betting against (shorting) the housing market. The film employs some unconventional techniques to explain complex financial terms – Ryan Gosling uses Jenga to explain tranches in mortgage-backed securities, Selena Gomez explains the ripple effect caused by collateralised debt obligations during a game of blackjack, and, in a cameo appearance, Margot Robbie explains sub-prime mortgage-backed securities, whilst in a bubble bath, drinking champagne. Another wonderful example of the financial world meeting Hollywood.

Click here to read our recent article on short selling bans and market restrictions and the considerations for investors.

 

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