Hong Kong
19 February 2013
Hong Kong has some built-in benefits when it comes to securities lending, but the country must address the cost of shorting, as SLT finds out
Image: Shutterstock
Securities lending first kicked off in Hong Kong when its monetary authority’s Central Money Markets Unit (CMU) launched a lending programme for private sector debt securities on 1 December 1997.
The programme aimed to enhance the liquidity and settlement efficiency of CMU private sector debt securities, and increase their attractiveness to investors by enhancing the yields for lenders.
Drawing on the success of the market-making system for the exchange fund paper, the programme allowed CMU members that were prepared to act as market makers of private sector issues to borrow securities from other CMU members to cover their short positions. The market makers were required to quote two-way prices at a reasonable spread during money market hours.
Fast-forward 13 years to 2010, and the industry was in a state of flux. Hong Kong was not hit too hard by the credit squeeze, but the number of participants in securities lending was falling (due in part to increased conservatism among lenders), and consolidation meant that smaller companies were falling off the radar.
However, Hong Kong has a few built-in advantages that will ensure the continuance of a fairly vibrant lending market. The Pan-Asian Securities Lending Association (PASLA) was founded in Hong Kong in 1995 and has been vital in growing the Asian markets. Since Hong Kong is the regional headquarters for many financial firms, it is easy for borrowers and lenders to meet there and resolve any issues.
Disadvantages to the region do exist. There is an exemption from stamp duty for properly executed transactions, but it must be claimed by filing the stock lending agreement with the Inland Revenue Department, which is not particularly convenient for industry players. Also, Hong Kong shorting has become extremely costly in the last couple of years. In a September 2012 blog post, Will Duff Gordon, research director at Markit Securities Finance, said: “If you thought, like me, that the cost of short selling in Hong Kong could not get any higher since a year ago then you are wrong. Admittedly, this rise in the cost of borrowing plateaued over the last few months, but this was after a continued rise for nine consecutive months.”
He stated that the number of shares on loan in Hong Kong for more than 500 basis points increased from 13 percent of securities to 21 percent, compared to just 2 percent in Japan.
“Securities lending is widely used to provide coverage for short selling transactions in the market,” said a spokesperson for Hong Kong Exchanges and Clearing (HKEx) on shorting in the region. “HKEx currently does not have any policy overseeing securities lending activities. However, short selling activities are regulated under the Securities and Futures Ordinance (SFO), where naked or uncovered short selling is strictly prohibited unless exemption is granted.”
The Stock Exchange of Hong Kong tightened the rules that regulate the short selling of designated securities in May 2012, after it conducted a review earlier in the year.
The move to tighten restrictions followed the enactment of similar legislation in the US and Europe, with the exchange planning to increase the eligibility criteria for market capitalisation and turnover velocity from HKD$1 billion to $3 billion and 40 percent to 50 percent respectively.
In a statement, the exchange said: “The change reflects the fact that the average market capitalisation of listed companies in Hong Kong has grown by around three times and the market turnover velocity has increased from around 40 percent to over 50 percent in the past decade.”
“Had the new short selling eligibility criteria been adopted in the last quarterly review in April [2012], 82 out of the existing 646 designated securities would have become ineligible for short selling.”
After the announcement, tech companies rushed to find answers, with providers TORA and Paladyne releasing reporting solutions that promised to meet the Securities and Futures Commission’s (SFC) requirements.
TORA said that its new solution aimed to enable hedge funds to meet the Hong Kong requirements by consolidating a report of short positions that comply with both the SFC’s approved list of equities, which can be shorted, and the newly prescribed reporting thresholds.
The report tool integrated with the TORA Compass execution and order management platform to generate reports on demand or scheduled reports for the weekly or daily requirement that were set by the SFC.
Paladyne Systems added capabilities to its order and portfolio management solution, Paladyne Portfolio Master, which automatically imports the SFC’s database of companies that must disclose short sale positions and allows clients to generate daily monitoring reports.
The new rules from the SFC came into effect on 18 June 2012, with the first reporting day of net short positions on 22 June and a T+2 reporting deadline on 26 June. Net short positions were then required to be reported weekly with a contingency for the SFC to enforce daily reporting in the event, for example, of a rapid market decline.
On the issue of stamp duty, the HKEx spokesperson argued that from the market participants’ perspective, the stamp duty exemption helps to lower the overall transaction cost. “The lower cost probably helps to boost the usage of securities borrowing and lending transactions in various business activities such as equity financing, short selling, failed settlement coverage, equity conversion for arbitrage opportunities, etc. These business activities, in turn, help to boost the cash market’s turnover as a whole and thus benefits Hong Kong.”
The belief that more regulation equals less risk that dogs markets so much seems to be present in Asia. Although regulations around what is required prior to executing a short sale are less onerous than countries such Australia, Hong Kong needs to check itself against the rest of the world, because Asia’s continued yet stunted growth could negatively affect the country’s securities finance market unless it rectifies some of its shortcomings.
The programme aimed to enhance the liquidity and settlement efficiency of CMU private sector debt securities, and increase their attractiveness to investors by enhancing the yields for lenders.
Drawing on the success of the market-making system for the exchange fund paper, the programme allowed CMU members that were prepared to act as market makers of private sector issues to borrow securities from other CMU members to cover their short positions. The market makers were required to quote two-way prices at a reasonable spread during money market hours.
Fast-forward 13 years to 2010, and the industry was in a state of flux. Hong Kong was not hit too hard by the credit squeeze, but the number of participants in securities lending was falling (due in part to increased conservatism among lenders), and consolidation meant that smaller companies were falling off the radar.
However, Hong Kong has a few built-in advantages that will ensure the continuance of a fairly vibrant lending market. The Pan-Asian Securities Lending Association (PASLA) was founded in Hong Kong in 1995 and has been vital in growing the Asian markets. Since Hong Kong is the regional headquarters for many financial firms, it is easy for borrowers and lenders to meet there and resolve any issues.
Disadvantages to the region do exist. There is an exemption from stamp duty for properly executed transactions, but it must be claimed by filing the stock lending agreement with the Inland Revenue Department, which is not particularly convenient for industry players. Also, Hong Kong shorting has become extremely costly in the last couple of years. In a September 2012 blog post, Will Duff Gordon, research director at Markit Securities Finance, said: “If you thought, like me, that the cost of short selling in Hong Kong could not get any higher since a year ago then you are wrong. Admittedly, this rise in the cost of borrowing plateaued over the last few months, but this was after a continued rise for nine consecutive months.”
He stated that the number of shares on loan in Hong Kong for more than 500 basis points increased from 13 percent of securities to 21 percent, compared to just 2 percent in Japan.
“Securities lending is widely used to provide coverage for short selling transactions in the market,” said a spokesperson for Hong Kong Exchanges and Clearing (HKEx) on shorting in the region. “HKEx currently does not have any policy overseeing securities lending activities. However, short selling activities are regulated under the Securities and Futures Ordinance (SFO), where naked or uncovered short selling is strictly prohibited unless exemption is granted.”
The Stock Exchange of Hong Kong tightened the rules that regulate the short selling of designated securities in May 2012, after it conducted a review earlier in the year.
The move to tighten restrictions followed the enactment of similar legislation in the US and Europe, with the exchange planning to increase the eligibility criteria for market capitalisation and turnover velocity from HKD$1 billion to $3 billion and 40 percent to 50 percent respectively.
In a statement, the exchange said: “The change reflects the fact that the average market capitalisation of listed companies in Hong Kong has grown by around three times and the market turnover velocity has increased from around 40 percent to over 50 percent in the past decade.”
“Had the new short selling eligibility criteria been adopted in the last quarterly review in April [2012], 82 out of the existing 646 designated securities would have become ineligible for short selling.”
After the announcement, tech companies rushed to find answers, with providers TORA and Paladyne releasing reporting solutions that promised to meet the Securities and Futures Commission’s (SFC) requirements.
TORA said that its new solution aimed to enable hedge funds to meet the Hong Kong requirements by consolidating a report of short positions that comply with both the SFC’s approved list of equities, which can be shorted, and the newly prescribed reporting thresholds.
The report tool integrated with the TORA Compass execution and order management platform to generate reports on demand or scheduled reports for the weekly or daily requirement that were set by the SFC.
Paladyne Systems added capabilities to its order and portfolio management solution, Paladyne Portfolio Master, which automatically imports the SFC’s database of companies that must disclose short sale positions and allows clients to generate daily monitoring reports.
The new rules from the SFC came into effect on 18 June 2012, with the first reporting day of net short positions on 22 June and a T+2 reporting deadline on 26 June. Net short positions were then required to be reported weekly with a contingency for the SFC to enforce daily reporting in the event, for example, of a rapid market decline.
On the issue of stamp duty, the HKEx spokesperson argued that from the market participants’ perspective, the stamp duty exemption helps to lower the overall transaction cost. “The lower cost probably helps to boost the usage of securities borrowing and lending transactions in various business activities such as equity financing, short selling, failed settlement coverage, equity conversion for arbitrage opportunities, etc. These business activities, in turn, help to boost the cash market’s turnover as a whole and thus benefits Hong Kong.”
The belief that more regulation equals less risk that dogs markets so much seems to be present in Asia. Although regulations around what is required prior to executing a short sale are less onerous than countries such Australia, Hong Kong needs to check itself against the rest of the world, because Asia’s continued yet stunted growth could negatively affect the country’s securities finance market unless it rectifies some of its shortcomings.
NO FEE, NO RISK
100% ON RETURNS If you invest in only one securities finance news source this year, make sure it is your free subscription to Securities Finance Times
100% ON RETURNS If you invest in only one securities finance news source this year, make sure it is your free subscription to Securities Finance Times
