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The government ban and new disclosure regime for short-selling are misguided and had exacerbated sharemarket volatility, while the opacity of securities lending covered up risks for super funds, the Risk- Metrics Governance conference was told in late March. The “two-tiered market” resulting from the ban, in which financials and selected other companies could not be shorted had caused “uncertainty, declining valuations and increased volatility,” said Tim McGowen, the outgoing chief executive of hedge fund Fortitude Capital.

The managing director of long-only boutique Balanced Equity Management, Andrew Sisson, said regulators had seemingly failed to recognise that short-sellers usually offset their trades by either going long a particular stock or the index. “The idea that shorting depresses the whole market is misguided,” Sisson said. The new short-selling disclosure requirements were “worse than useless” since they did not reveal the accompanying long trades made by the same investors.

McGowan said that only a “fraction” of shares in a company out on loan – about 5 per cent – were used for directional short-selling, and that shorting was a valid risk management technique used to hedge duration risk on long bets. “Shorting an overpriced stock is a better risk management practice than holding a stock just because it’s in the index,” he said. Helen Nugent, chair of Funds SA but also a director of Macquarie Bank, a major beneficiary of the ban, diplomatically focussed on the operational risks that super funds are exposed to through securities lending programs.

She said these risks had been neglected in the shorting debate and that funds with securities lending programs were guilty of not monitoring custodians to ensure they are maintaining their contractual obligations, in addition to their relationships with sub-custodians. “[Contracts] are often signed and then put in the bottom drawer. Super funds should put in place improved monitoring processes,” Nugent said. “I will be the first to admit that this is a difficult process.” She said custodians’ relationships with sub-custodians around the world was an area worth monitoring.

The prices of securities on loan were unaffected by market moves, meaning that pricediscovery in securities lending was flawed, Nugent said. Funds were also not adequately rewarded for the risk they take when loaning securities, she contended. Many are now facing losses in the cash pools that were used as collateral against lending programs and were invested by the custodian on the fund’s behalf. “Even if it is managed by the agent it is the responsibility of the super fund,” she said. “Custodians have a volume incentive. Super funds have a pricing incentive.”

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