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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

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

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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