Short selling gets short shrift

Saturday, 14th June 2008 17:23 - by Resident IFA

The Financial Services Authority (FSA) has updated their Handbook with the introduction (from June 20th) of a ‘Short Selling Instrument’. This is aimed at preventing the abuse of rights issues. As I understand it, a rights issue is where a company issues more shares to existing holders at a discounted price to that which it is currently trading. The company in question could be doing this for a number of reasons – help shore up their balance sheet, help in repaying loans, expanding, etc. Banks such as HBOS and Bradford & Bingley have recently gone to the market for more money via a rights issue. The issue of the extra shares can have the effect of: a. Diluting existing holdings as there are more shares on the market, thus the share price could fall, and b. Lead to a share price fall based on market sentiment as the company may have started the rights issue process for the ‘wrong’ reasons (Perhaps propping-up the balance sheet as opposed to a positive reason such as seeking funds for expansion). The FSA’s intervention centres on ‘short’ sellers i.e. those that are betting on the share price to fall as a result of the rights issue and the aforementioned reasons. If enough people hold short positions, this in itself could perpetuate a share price fall. The aim of the new instrument is to lessen the volatility of the share prices of companies involved in an imminent rights issue by negating the effect of the short seller through transparency. The short position, if ‘an economic interest of one quarter of one per cent of the issued capital of a company’, has to be made public ‘by no later than 3.30pm on the business day following the date on which the disclosable short position is reached or exceeded’. This edict applies from the first to last day of a rights issue i.e. from announcement to completion. Those companies thinking of making a rights issue might now be breathing a little easier, comfortable in the knowledge that the FSA’s affirmative action should somewhat stop the rollercoaster volatility we have seen in recent weeks. HBOS, for one, is happy. After the trials of the last week where their share price dropped below the rights issue price, their share value closed 13.69% up at 321.75p after the FSA’s announcement. Until next time…