February 21, 2018 / 12:45 PM / 10 months ago

Bridgewater’s bet against Europe shines light on patchy short-selling rules

LONDON (Reuters) - The world’s largest hedge fund Bridgewater Associates caused a stir last week when it disclosed it had made $22 billion (15.78 billion pounds) worth of bets against European companies, including giants such as Unilever (ULVR.L) and Siemens (SIEGn.DE)

FILE PHOTO - The signature of the President of the European Central Bank (ECB), Mario Draghi, is seen on the new 50 euro banknote during a presentation by the German Central Bank (Bundesbank) at its headquarters in Frankfurt, Germany, March 16, 2017. REUTERS/Kai Pfaffenbach

But patchy rules on the practice known as “short-selling” mean it is difficult to tell if Bridgewater’s positions are a bet against Europe specifically, or broader scepticism on global equities.

Following is an explainer on the practice of short-selling and how it is treated in various jurisdictions:

WHAT IS SHORT-SELLING?

Essentially it is a bet that the price of the share will decline.

Short-sellers borrow stock from those that own it, say pension funds, then sell it into the market, hoping to buy it back at a lower price. They can then return the shares to the owner, pocketing the difference.

In the European Union, funds with short positions greater than 0.5 percent of a company’s shares are required to publicly disclose these with the respective regulator – which is how Bridgewater’s bet came to light.

But in many other countries, including the United States, home to several of the world’s largest stock markets, similar regulations do not apply.

On the one hand, regulators want to ensure transparency in financial markets by making sure investors are aware of short-interest in a company, according to James Clunie, a hedge fund manager at Jupiter Asset Management who has written a PhD and several books on short-selling.

But on the other hand, academic studies have shown that allowing short-selling makes markets function more effectively.

Supporters argue the practice adds to market liquidity - a 2011 study in the Journal of Financial Economics found short-selling accounted for 40 percent of the dollar value traded in U.S. stocks.

It also acts as a check on shares’ propensity to ignore fundamentals and keep rising in a bull market and can act as an early warning signal of problems at companies, they add.

EUROPE LEADS

The EU introduced harmonized short-selling regulation in November 2012 with the aim of increasing transparency and reducing settlement risk.

These rules require funds with short positions to report to the respective regulator if their short positions are above 0.2 percent. When the figure reaches 0.5 percent these positions are made public.

Japan is one of the few countries outside of Europe to match the EU’s disclosure limits of 0.2 and 0.5 percent.

Neighbouring Korea introduced the public 0.5 percent disclosure threshold in June 2016.

In other countries, including Australia and Canada, short-sellers are required to report short positions to the regulator. This data is then aggregated and released but individual funds’ positions are not made public, no matter how large.

So the data may show for instance that 8 percent of the outstanding stock in a company is out on loan but will not reveal who has taken those positions.

REGULATORY DIVERGENCE CAN BENEFIT SHORT-SELLERS

Hedge funds sometimes can use this regulatory divergence to their advantage.

When shares in German-listed retailer Steinhoff (SNHG.DE) collapsed in December 2017 after it admitted accounting irregularities, no hedge fund had reported short positions to the German regulator – a rarity for a company that was being probed by German tax investigators for several years.

But because Steinhoff used to have its primary listing in Johannesburg and still has shares listed there, most investors wanting to bet against the firm had used the lack of disclosure rules in South Africa to short the stock, said a hedge fund manager who held a short position in Steinhoff’s South African-listed shares (SNHJ.J).

U.S. MOVES

In the United States too, aggregate data exists but there is no requirement to report individual short positions.

So market players may have to resort to securities lending data from independent providers such as Markit to gauge the current short-selling picture.

The 2010 Dodd Frank law asked the Securities and Exchange Commission (SEC) to study the feasibility of introducing a real-time short position reporting regime but it concluded in 2014 that this would be too costly.

The Nasdaq stock exchange has lobbied for stricter disclosure requirements, saying in a 2015 letter to the SEC that the lack of short position disclosure rules was harming market efficiency and shareholder engagement.

A recent report said it wanted to match the disclosure requirements when owning the stock, where positions of larger than 5 percent must be reported.

Reporting by Alasdair Pal,; Additional reporting by Michelle Price in WASHINGTON, Dahee Kim in SEOUL, Tomo Uetake in TOKYO and Swati Pandey in SYDNEY,; Editing by Sujata Rao and Richard Balmforth

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