Managers of fast-growing strategies that employ shorting, such as 130/30 and market-neutral, say temporary new regulatory restraints on short-selling should affect their business only marginally — as long as the Securities & Exchange Commission (SEC) decree targeting 19 financial stocks doesn’t lead to broader restrictions. “If it only impacts these 19 companies, then it’s not a big deal,” said Ric Thomas, a senior managing director and department head of the US enhanced equity group at State Street Global Advisors.
However, amid a number of uncertainties about how the SEC order would be implemented from the 21st of last month, Thomas noted concerns that the new rule could be extended in a way that affects the broader market. Citing the need to quash malicious short-selling that could destabilise the US financial system, the SEC’s July 15 emergency order left prime brokers scrambling to figure out the ramifications of the greater oversight promised by regulators to prevent “naked” short selling. Naked short selling is when managers do not borrow shares before selling them.
The stocks on the SEC’s list include several whose ability to survive the credit crunch of the past year has been called into question, including mortgage giants Federal National Mortgage Association and Federal Home Loan Mortgage Corp. and investment bank Lehman Brothers Holdings. While it’s unclear how much the looming restrictions were responsible, those stocks soared in the days after they were announced.
A number of managers offering 130/30 or market-neutral strategies say they’ve already been living by the stricter standards that the SEC appears to be imposing on those 19 financial stocks. “If this becomes a more significant move to stop shorting completely, it would be another story, but we’ve always identified shorts available before we trade,” said John Chisholm, chief investment officer of Boston-based Acadian Asset Management.
“We thought the rules they announced were the rules we were following,” and the bigger surprise is the implication that the stocks not on the list are being held to less rigorous standards, said William E. Jacques, CIO of Martingale Asset Management .
On July 16, officials at the Securities Industry and Financial Markets Association, Washington, asked the SEC for clarifications “on a number of important issues.” Spokesman Travis Larson declined to identify the specific issues under discussion. One question cited by money managers is whether prime brokers, who until now have “located” more shares for money management clients to short than they could identify — in the same manner that an airline, expecting a certain number of no-shows, books more reservations for a flight than it has seats available — will have to apply stricter limits.
In that case, “those 19 stocks may be more difficult to borrow, and the cost of borrowing would likely rise,” said Russell Kamp, the New York-based chief executive officer of the global structured product group at Invesco. One prime broker, who declined to be identified, said it’s a good bet that the costs of borrowing shares will head higher. For now, market veterans say any upward pressure on shorting costs is likely to prove manageable.