Europe Makes Effort to Shed a Light on Short Selling
The hedge fund manager David Einhorn does not seem to mind revealing his bets against a company, at least on his own terms.
Over the years, Mr. Einhorn, the founder of Greenlight Capital , has announced several major short positions, most notably in 2008 when he publicly derided Lehman Brothers just months before the investment bank collapsed.
But now Mr. Einhorn and other large investors do not have a choice in France, where regulators started requiring money managers to disclose on a daily basis the stocks they bet against in the country.
On Feb. 3, Greenlight Capital reported it was short more than 1 percent of the shares in Neopost, a French mailroom equipment supplier.
While hedge funds have long had to report their long positions on a quarterly basis, the decision by French authorities brings a new level of transparency to some of the most closely guarded investment moves in the hedge fund world.
In February, the Autorité des Marchés Financiers, the French financial markets regulator, began requiring hedge funds and other investment managers to disclose their short positions when they reached 0.5 percent of a company’s outstanding stock.
The initiative mirrors a plan by European Union regulators who, in the wake of the financial crisis, want to monitor the potential risks of short-selling.
The European Commission is considering a proposal that would require all member countries to publish details on investors’ short holdings. Authorities are expected to vote on the measure this year.
“It’s definitely a step in the right direction in terms of providing transparency,” said Andrew Lo, professor of finance at the Massachusetts Institute of Technology, who has studied hedge funds for more than a decade.
“While it is good for the public, there is a potential for unintended consequences.”
The action in Europe goes well beyond the efforts of regulators and policy makers in the United States.
As part of the Dodd-Frank financial reform act, the Securities and Exchange Commission is drafting rules that would require hedge funds to disclose greater detail about their positions, leverage and performance — although the information would not be public.
Investors short stocks for many reasons. They may think a company’s shares are overvalued and headed for a fall. Or they want to cut risk in their portfolio.
But the practice has long been contentious. The defenders say such bets provide liquidity to the market and improve price efficiency. Critics contend it accelerates stock losses, adding unnecessary volatility in times of market stress.
There is scant information on short-selling. Limited details are often published on a delayed schedule or in aggregate form, making it hard to know the size and scope of such positions.
Companies have long complained that short-selling can lead to stock manipulation.
In the financial crisis, managers at Bear Stearns and Lehman Brothers accused large investors of spreading rumors that sent their prices plummeting and created liquidity problems for the investment banks.
At the time, several countries — including the United States, Britain, Germany and France — banned the practice for shares in certain companies. Since then, the bans have largely been lifted.
As lawmakers across Europe search for ways to prevent another crisis, countries in the region have adopted their own policies around the investment strategy, with the French rules sitting on the more stringent end of the regulatory continuum.
German officials voted on Jan. 31 to extend a rule requiring the disclosure of short positions in the stocks of 10 companies, including Deutsche Bank.
Unlike in France, the information is disclosed on an aggregated basis, showing the collective short positions of money managers on a single stock.
Since 2008, Britain’s Financial Services Authority has forced firms to report short positions for 30 financial companies, including the investment bank Barclays Capital.
The European Union is moving to create a uniform policy for its 27 member countries. The plan, issued last September, would require firms with short positions of 0.5 percent of an available stock to publicly disclose it.
The proposed legislation, which could change as it wends its way through the system, is expected to come up for a vote this year.
The patchwork of regulation — and the looming threat of comprehensive rules in the euro zone — have prompted hedge funds to beef up their lobbying efforts.
The industry’s main trade group in the United States, the Managed Funds Association, said it planned to open an office in Brussels, the headquarters of the European Commission.
The trade group has also sent letters asking European authorities to maintain the records privately, or post them anonymously or in aggregate.
The industry argues that such disclosures could spawn copycats, unsophisticated investors who see the moves of respected hedge funds like Greenlight and decide to follow suit.
Such piling on could lead to unfair downward pressure on a company’s stock.
A spokesman for Greenlight Capital declined to comment. Others say that if market participants stop shorting to avoid the regulatory disclosures, liquidity will dry up and the market will be less efficient.
A study by the British financial regulator in the aftermath of the crisis found that liquidity and pricing suffered for those stocks that investors were banned from shorting. But there isn’t a lot of research on how disclosing individual short positions will affect the market.
Two industry-financed studies suggest that investors will be at risk if the proposed legislation passes.
One study, commissioned by the Managed Funds Association, found that trade volume dropped 13 percent in those stocks subject to disclosure rules in Britain and the gap between the buy and sell offers on a stock increased 45 percent.
The research, however, is hardly definitive, experts say. Indeed, many feel the rules would be a good way to balance what is good for the markets with what is good for the public.
“It’s going to affect just large hedge funds who are putting on fundamental shorts,” said Charles Jones, a finance and economics professor at the Columbia Business School.
“It might discourage them from doing that, and it might mean that prices take longer to adjust to negative information. But it won’t destroy market quality in the same way the ban did.”