Proposal to Expand Reporting on Short Sales
In the early days of the COVID-19 pandemic, international securities markets experienced significant economic dislocations and erosion in share pricing. Some investors took advantage of those markets by increasing their short sale positions, which led market regulators in several countries to impose restrictions on short sales activities. Early data now suggests that securities markets in countries that did not impose onerous restrictions fared much better in terms of share price stability and liquidity, which supports the theory that short sales facilitate a more efficient market for all investors.
Intelligent short sale disclosure and regulation are the keys to maintaining market efficiency in uncertain markets. Because of this, the Financial Industry Regulatory Authority (FINRA), which has the authority to license and regulate broker-dealers in the U.S. securities markets, recently proposed amendments to short sale reporting requirements for its members in the U.S. markets. If adopted and implemented, those amendments will have a positive impact on the securities lending industry, which, in part, supports short sale activity by enabling investors to borrow shares to cover short positions.
FINRA has specifically proposed to consolidate the publication of short interest data for both listed and unlisted securities and to make that data fully transparent and freely available on its website. Currently, FINRA treats OTC equities transactions and exchange-listed securities differently. FINRA’s proposed amendment implicitly recognizes the growing number of unlisted securities that are traded on electronic markets.
Another of FINRA’s proposed amendments would require securities trading firms and investment banks to report their synthetic short positions. Synthetic shorts are options strategies that investment managers use to simulate the payoff of a short stock position. In theory, the strategy offers unlimited profit potential, but that potential is offset by unlimited risk. FINRA’s proposal to include this data in short sale reports indicates the growing popularity of the strategy.
From a broader perspective, FINRA’s inclusion of synthetic short sale data, which is an options and not a direct short sale strategy, reflects the Authority’s focus on full disclosure of all share sale interests and information on total shares outstanding and the public float. Even if FINRA had been focusing on the disclosure of this information for some time, the pandemic drove home the importance of full disclosure of all short interest data and likely prompted FINRA to include this disclosure obligation in its proposed amendments.
The proposed amendments will likely have little or no immediate impact on the stock loan and securities lending industry. FINRA has jurisdiction over activities in the United States. It remains to be seen if other jurisdictions will adopt similar disclosure requirements. If data from the early days of the COVID-19 pandemic remains consistent, that data may compel other jurisdictions to pursue that path and to offer greater support to short sale activity and strategies.
Even if they do not actively use collateral shares in a short sale environment, securities lending and stock loan institutions have a vested interest in that environment. Share liquidity is a critical component for a robust stock loan offer. Collateral stock that exhibits a stronger trading pattern will always support terms and conditions that are more favorable to an investor, including lower interest rates and higher loan-to-value ratios. Investors that incorporate securities lending and stock loans as a component of a complete wealth management strategy would do well to support the adoption of regulations that increase transparency and disclosure of short sale data in the markets in which they participate.