Tracking the short-sellers

Short-sellers are now a regular fixture of the stock market, yet most investors still do not have enough information to get a handle on what they are doing.

But as prominent investor and writer Jim Rogers observed in his book Street Smart, short-sellers have a better record at getting their bets right compared with most traders because they can lose big time if they get it wrong.

So it would be useful for the rest of us to get a fairly accurate picture of how widespread their activity is in order to gauge the level of bearish sentiment surrounding a stock or the market in general, so that we can better make an informed decision on our investments.

Short-sellers borrow scrip in the securities lending market to sell in the hope of making a profit by buying it back cheaper later.

But while they may play a role in shining an unwelcome spotlight on under-performing firms, some of them get plenty of brickbats for the hardball tactics they use when they ambush a company after building a big "short" position on it.

One of the best sources of information on short-sellers' activities I have seen is the data provided by the financial information firm Markit, which shows the percentage of shares out on loan in a listed firm. But this is only available to subscribers.

Markit said it can amass data based on the contributions it receives from lenders and borrowers active in the securities lending market. This in turn gives its customers an aggregate view of the short-interest in a counter, sector or even an index.

But in the public domain, the Singapore Exchange's offerings are far from satisfactory.

Since 2013, the SGX has required all sell orders to be marked as either normal (one backed by shares already owned by the seller), or short-sale, which is backed by borrowed scrip.

But such data does not give an accurate picture of the short-sell interest, as a trader's original trade would still have been captured as a "short-sell" position in the SGX report even if he had covered his "short" purchases before the end of the trading day.

To try to further level the playing field, regulators came out with a proposal in 2014 to require short-sellers to report their positions if they amount to at least $1 million, or 0.05 per cent, of a listed firm's shares.

These "short" positions would then be added up and published on a weekly basis without disclosing the investors' identities.

But this proposal has still not been implemented. A spokesman for the Monetary Authority of Singapore said: "We plan to publish the short-selling regulations in the second half of 2017."

After that, a reasonable "transition" timeframe will be given in order to allow market participants and industry to familiarise themselves with the requirements before the regime takes effect.

In the meantime, small-time investors have been flying blind, so to speak, if they have to make decisions on stocks that have attracted huge wagers from short-sellers.

Take Ezra Holdings, which put up a tenacious but ultimately futile struggle to stay afloat as demand for its offshore support vessels collapsed. This was in the wake of the huge cutbacks in capital expenditure by oil majors as crude prices plunged over the past three years.

While its struggles early this year were well-documented in the financial media, Markit data shows that short-sellers were already thick in the action, stalking the company as far back as mid-2014 when there were few signs that it might go under.

Not that Ezra went down without a fight. Its problem was that it had taken on too much debt to expand its business when times were good, and it found itself caught in a financial bind as revenues dried up with the collapse of oil prices.

And despite a US$300 million (S$416 million) rights issue to repay part of its debt that temporarily staved off further attacks on its share price by short-sellers, a further souring of the big picture soon had them encircling the company.

Ezra finally went kaput in March and filed for Chapter 11 bankruptcy protection in the United States after its joint venture, Emas Chiyoda, went bust. When it suspended trading, 8.8 per cent of its shares were still out on loan, presumably to short-sellers.

Then there is beleaguered commodities trading house Noble Group, another heavily shorted stock, whose run-ins with an anonymous outfit called Iceberg Research over its accounting practices turned out to be a disaster for its business and stock price.

It didn't help that this turmoil coincided with a slump in commodity prices.

Markit data shows that each time Noble held a fund-raising exercise - a US$500 million rights issue in June last year and a US$750 million bond issue in March this year - the percentage of shares out on loan dropped by a big margin.

But such triumphs turned out to be short-lived, with short-sellers taking up arms to attack the company again when it was hit by yet another spate of bad news, including the US$129.4 million loss for the quarter ended March.

Still, with the exception of Noble, the local bourse has been enjoying a respite from the unwelcome attention of short-sellers as they switched their attention to the far larger and much more liquid Hong Kong market, where at least six listed firms have fallen prey to their predatory selling in the past three months.

And prominent short-sellers such as Muddy Waters' Carson Block have suffered setbacks in recent weeks as the bearish bets they took on the companies blew up in their faces.

But this happy state of affairs is unlikely to last forever, and my gut feel is that these bears will eventually have their day again when market fundamentals eventually re-exert themselves.

As such, one question to be raised is whether more can be done during this period of respite to improve the disclosure of short-selling activity.

In Hong Kong, the hotbed for short-selling these days, the HK Exchange publishes two short-selling reports every day.

These should presumably give investors a better handle to gauge the level of bearish activity on a counter, especially if they are confronted with a damning report from a short-seller trying to panic them into dumping their shares.

To further protect small- capitalised and thinly traded stocks from falling prey to short-sellers, Hong Kong also has a list of criteria on stocks that can be shorted. These include having a market value of at least HK$3 billion (S$535 million) and an aggregate turnover in the preceding 12 months that is at least 60 per cent of the stock's market value.

If anything, adopting similar practices such as those now in place in Hong Kong will go a long way towards levelling the playing field for retail investors.

True, short-sellers may play an important role as the discoverers of bad news, providing both liquidity and stability to the market and preventing any stock market bubble from inflating out of hand.

But unless other investors are aware of their trading activities, short-sellers will be bad news every time they strike.

June 26, 2017


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