[Podcast] Experiences of several countries on the trading mechanism and information disclosure activities in short selling

Keywords: short selling, trading mechanism, information disclosure.

Short selling has long been a popular trading method in the financial market in general and the stock market in particular. In Vietnam, short selling is a product recognized by law since February 15, 2021. However, up to now, transactions related to short selling have not officially come into operation for many reasons, including legal risks. The purpose of this study is to review the trading mechanism and information disclosure activities in short selling through current regulations in some countries, thereby, providing implications for Vietnam.

Short selling is a trading strategy in the financial market that allows investors to profit from predicting the price of an asset listed as a security (stock, bond) or commodity having decrease in the future. A unique point in short selling is that stock investors can  short sell without having to own stocks or bonds at the time of the transaction. In other words, short selling is the sale that an individual/organization does not own in the stock market. For example, in Circular MRD/DoP/SE/Dep/Cir-14/2007 of the Securities and Exchange Board of India (SEBI), short selling is defined as the sale of shares that the seller does not own at the time of the transaction. As of 2023, short selling in the stock market has been recognized by the Government of many countries and territories. Many countries have built independent legal regulations on short selling transactions, focusing on checking and monitoring the operating mechanism of short selling, assessing risks and improving the transparency of transactions through information disclosure activities.

Operating mechanism of short selling

Currently, in most other jurisdictions in the world, short selling without collateral is prohibited. In Vietnam, in Circular No. 120/2020/TT-BTC, short selling with collateral is defined as the sale of securities that have been borrowed on the securities lending and borrowing system of the Vietnam Securities Depository and Clearing Corporation. The seller is obliged to buy back those securities to repay the loan.

Mechanism of short selling transactions in the market

In terms of trading mechanism, short selling transactions are formed on the stock market based on the principle of borrowing and returning stocks. If the stock price decreases, the short seller will buy back the stocks at a lower price and make a profit. If the stock price increases, the short seller will lose. The characteristic of businesses that are selected for short selling is that the actual profitability is very low compared to the “huge” valuation on the current stock market. In general, the mechanism of short selling is a transaction mechanism that both sells and buys stocks.

Most countries that allow short selling require a deposit of 150% of the value of the position at the time the short sale is made. This is considered the initial margin. If the value of the position falls below the maintenance margin requirement, the short seller will face a margin call and be required to close the position or add money to the margin account.

There are different regulations for short selling in each country. In Malaysia, a short sale transaction is stipulated to not exceed 12 months from the transaction date. Short sales transactions and corresponding loans must be confirmed through RENTAS (Bank Negara Malaysia’s payment system) on the corresponding transaction dates. The Securities Commission of Malaysia has the power to (1) disallow short selling transactions; (2) suspend short selling of certain securities; (3) take any other action that the Securities Commission deems appropriate for the market.

Short selling transactions in the United Kingdom require investors to ensure that three activities are fully performed: (1) borrowing securities from the lender; (2) receiving consent to borrow securities from the lender; (3) having an agreement between the borrower and the lender on placing a short sale order for securities, ensuring the quantity of securities as prescribed and complying with the principles of securities trading.

Disclosure of information in short selling transactions

Some countries are gradually paying more attention to the obligation to disclose information in short selling transactions. In the European Union (EU), the regulations on notification obligations when conducting short selling transactions are in the direction of stricter control. Any individual or legal entity holding a short position equal to or greater than 0.1% of the share capital of an enterprise must comply with the obligation to notify the competent authority of the short position within one trading day. In the case of a net short position equal to or greater than 0.5% of the share capital, the competent authority must make a public announcement.

In the UK, the regulatory notification threshold requires a short seller to notify the Financial Conduct Authority (FCA) when the net short position exceeds 0.1% of the issued share capital of the enterprise, calculated on the total value of the market trading. Specifically, short sellers are required to report incremental changes in trades above the 0.1% threshold as prescribed.

In Malaysia, to control the risk in short selling transactions, participants are required to: (1) report on a weekly basis any outstanding short positions during the day (classified by stock code); (2) promptly report any short positions with a value of 5% or more; (3) promptly report any failure to deliver (return) any securities from market participants.

In Japan, short selling transactions on the Japanese stock exchange must be fully reported. On behalf of short sellers, the securities company executing the short sale order is responsible for reporting short positions during the day. Specifically, short positions with a short ratio of 0.2% or more must be reported to the stock exchange. In case that the short selling position has a short selling ratio of 0.5% or more, it will be reported to the Stock Exchange and this information will be disclosed on the market.

Implications for Vietnam

First, short selling is a financial instrument that can bring many benefits to the market but has many potential risks. In the upcoming time, our country needs to issue detailed regulations on the operating and monitoring mechanism in the management of short selling transactions on the stock market, including: (1) Regulations on margin ratio, (2) Regulations on the reporting threshold of short selling positions, (3) Regulations on the content and time limit for information disclosure, (4) Regulations on the responsibilities of the parties participating in short selling transactions.

Second, full and transparent information disclosure is one of the important measures to control risks in short selling transactions. Vietnam can refer to the application of relevant regulations on information disclosure of parties participating in short selling transactions in a similar direction to EU countries, the UK, Malaysia or Japan. Specifically, short sellers must report to competent authorities as the short selling position reaches a certain threshold.

Third, short selling will be a new tool on the Vietnamese stock market if our country officially puts it into operation on the market. Like the derivatives market (operating from August 10, 2017) or covered warrants (operating from June 28, 2019), most investors need time to get acquainted with new securities products. Therefore, before the official pilot operation, it is necessary to strengthen propaganda and dissemination of knowledge regarding short selling transactions for investors to access and learn, helping investors clearly understand the opportunities and risks of short selling activities before participating in order to achieve the most optimal trading efficiency.

The full research article Experience of several countries on trading mechanisms and information disclosure activities in short selling can be accessed HERE.

The article was published in Journal of Banking in July 2024, an agency of the State Bank of Vietnam.

Author: Mr. Nguyen Hoang Nam – UEH College of Economics, Law and Government, University of Economics Ho Chi Minh City.

This article is part of the series spreading research and applied knowledge from UEH with the message “Research Contribution For All – Research for the Community”, UEH cordially invites readers to await the next UEH Research Insights #133 issue.

News, photos: Author, UEH Department of Marketing and Communication