Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Where is London’s alleged light touch?

At least when it comes to short selling in today’s troubled
markets, the UK Financial Services Authority’s vaunted light
touch has given way to a heavy handed approach that makes the US
regulators appear light touch. The US regulators have been content to
be silent spectators while outspoken short sellers attack key financial
institutions. Ackman has brought the bond insurer MBIA to its knees
and Einhort has put enormous pressure on Lehman without any rebuke
from any regulator.

By contrast, the FSA in the UK has ham handedly pursued those who
shorted the leading UK banks particularly HBOS. In April, I blogged
about the FSA initiating a probe into short selling in HBOS
shares. Since then, HBOS shares have fallen by almost 50% as a stream
of bad news has come out of the bank. In late April, HBOS launched a
rights issue at what was then a deeply discounted price of 275p. On a
couple of occasions recently, the share price has dropped below the
rights issue price threatening the success of this capital raising
effort. The FSA stepped in earlier this month with fresh regulations
against short selling in companies which are conducting rights
issues. The new regulations require public disclosures of any short
position exceeding 0.25% of the issued capital of a company that is
conducting a rights issue. The FSA stated:

The FSA views short selling as a legitimate technique which assists
liquidity and is not in itself abusive. But it is also the case that
the rights issue process provides greater scope for what might amount
to market abuse, particularly in current conditions. …

In addition to the new disclosure regime, we are also giving
consideration to whether it might be necessary to take further
measures in this area. We are currently examining a number of options
including the following: restricting the lending of stock of
securities in rights issues for the purposes of enabling short
selling; and restricting short sellers from covering their positions
by acquiring the rights to the newly issued shares.

Much of this is silly. It is precisely when a company is raising
billions of pounds of new capital from the public that investors need
the genuine price discovery that is promoted by short selling. As it
is, the FSA is dangerously close to complicity in a scheme to sell
overpriced shares to the public on the basis of an artificially
elevated share price. The FSA has been saved from this only by the
ineffectiveness of its measures in propping up the share price on a
sustained basis. After a short spike, the price has again been testing
the 275 level.

Meanwhile, press
reports
state
that the FSA is ending the probe that it launched in April –
apparently, it is unable to put together a case against anybody in
that case. If true, this vindicates all those who thought that the
investigation itself was misguided.

I think what we are seeing is a clear regulatory conflict of
interest. In its role as the supervisor of HBOS, the FSA seems to be
putting the health of HBOS above the health of the capital market
which it regulates.

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