Jessie Tan discusses the salient features of Bursa Malaysia's rules on regulated short selling
What is Short Selling?
Short selling is a technique used by investors to profit from the falling price of an overpriced market or security.
In 1992, George Soros “broke the Bank of England”. He risked US$10 billion that the British Pound would fall and was proven right. The next day he made US$1 billion from his trade. His profit eventually reached almost US$2 billion.
If an investor thinks that Stock X is overvalued at RM25 and is going to fall in price, he may sell it for RM25 even though he does not own any units of Stock X. If the price of Stock X falls to RM20, the investor will purchase the stock from the market to settle his trade and thereby make a profit of RM5 per share.
On the other hand, if the price of Stock X goes up to RM30, the investor will incur a loss of RM5 per share to buy Stock X to settle his trade obligation.
As a general rule, short selling is prohibited under Section 41(1) of the Securities Industry Act 1983 ("SIA") which provides inter alia that a person shall not sell securities unless at the time when he sells them, he had or believes on reasonable grounds that he has, a presently exercisable and unconditional right to vest the securities in a purchaser of the securities.
The SIA contains several exceptions to Section 41(1). The specific exception that is relevant to short selling is sub-paragraph (c) of Section 41(4) which states that Subsection (1) shall not apply to a sale of securities where:
(1) the rules of the stock exchange expressly provide that sub-paragraph (c) applies to that class of securities;
(2) the sale is made in accordance with the rules of the stock exchange; and
(3) at the time of the sale, neither the person who sold the securities, nor any person on behalf of whom that person sold the securities, was an associate, of the body corporate that issued or made available the securities.
Regulated short selling of prescribed stocks had previously been permitted by the Kuala Lumpur Stock Exchange. As a result of the Asian Financial Crisis, regulated short selling ("RSS") and Securities Borrowing and Lending ("SBL") were banned from 5 September 1997.
Reintroduction of Short Selling
The ban on RSS was lifted in March 2006 on condition that Bursa Malaysia Securities Berhad ("the Exchange") controls all short selling transactions. This resulted in amendments being made to the Rules of the Exchange ("Rules") vide Participating Organisations Circular R/R 16 of 2006 ("R/R 16").
At the same time, SBL was also reintroduced vide the issue of revised Guidelines on Securities Borrowing and Lending by the Securities Commission ("SBL Guidelines") and amendments to the Rules vide R/R 16.
The SBL Guidelines and the amendments to the Rules vide R/R 16 took effect on 3 January 2007.
Characteristics of RSS
RSS is defined in Rule 704.1(1) of the Rules as:
“the selling of approved securities where the seller does not at the time of the execution of the sale, have an exercisable and unconditional right to vest such securities in the purchaser but has prior to the execution of the sale, borrowed the approved securities or obtained confirmation from an Authorised SBL Participant that the Authorised SBL Participant has the approved securities available to lend, pursuant to a SBL Agreement as will enable delivery of the same to be made to the purchaser under the said sale, in accordance with the Rules relating to delivery and settlement in Chapter 8 ...”
It can be seen from the above that in every case, a RSS must be underpinned by an existing SBL Agreement to ensure that the seller is able to fulfil his settlement obligations in respect of the short sale. However, the converse is not necessary and a SBL arrangement can exist independently of, and be carried out for purposes other than, a RSS.
To ensure that there is sufficient liquidity, a security must fulfil the following criteria to qualify as an "approved security" for a RSS ("Approved Security"):
- its average daily market capitalisation must exceed RM500 million for the preceding 3 months;
- there must be at least 50 million shares in public float; and
- its average monthly traded volume must exceed 1 million units for the preceding 12 calendar months.
The Exchange reserves the right not to declare a security as an Approved Security notwithstanding that it fulfils all the above-mentioned criteria. The Exchange has declared 70 stocks as Approved Securities for the re-introduction of RSS. These include traditional blue chips such as Bumiputra-Commerce, Genting, Maybank, Maxis, Public Bank, Shell, Tenaga, Telekom and YTL. The list is to be reviewed by the Exchange approximately every six months.
Pre-Requisites of RSS
The Exchange has prescribed requirements that must be complied with before a Participating Organisation ("PO") may execute a RSS. A PO must establish internal guidelines for short selling and have in place systems and infrastructure which have all relevant functionalities and controls to carry out RSS. The PO is also required to submit a declaration in the prescribed form to the Exchange confirming its compliance with the foregoing requirements at least 2 market days before it commences RSS.
An investor who wishes to participate in RSS must open a designated RSS trading account ("RSS Account") with a PO. All short selling transactions are to be executed through a RSS Account.
Before a short-selling order can be executed, an investor must confirm to the PO that it is not associated (as defined in Section 3 of the SIA) with the body corporate that issued or made available the securities which is the subject matter of the RSS and that it has borrowed the relevant securities from an Authorised SBL Participant or procured confirmation from an Authorised SBL Participant that the relevant securities are available for borrowing.
Execution of RSS
A RSS order is entered into the Automated Trading System through a screen that is designated for RSS transactions. The Exchange has prohibited RSS from being carried out by way of direct business.
The Exchange has also laid down a ruling that the order price of the relevant securities must be higher than the last traded price of the relevant securities. This is known as the 'up-tick rule'.
Suspension of RSS
The Rules prescribe that the total short position of an Approved Security is limited to 10% of the total number of the shares or a class of securities of an issuer on a market day. When this limit is reached, RSS activities on that security will be suspended for 4 market days.
If there is a breach of any of the rules on RSS or where the Exchange suspects that RSS is being used for manipulative activities, the Exchange may, amongst other actions, suspend or restrict the short selling activities carried out by a PO, whether for itself or its clients.
The Rules prohibit a RSS from being executed in respect of an Approved Security which is the subject of a take-over during the 21-day period immediately following the take-over announcement.
The Exchange may also direct that RSS be suspended during the period where an Approved Security has been declared, and remains a Designated Security, i.e. a security in respect of which there has been manipulation or excessive speculation.
Restriction on Purchases for RSS Account
Securities may only be purchased for a RSS Account to contra, in full or in part, any Approved Security for which a RSS has been executed or for re-delivery of any Approved Security that has been borrowed under a SBL Agreement.
The Rules further prescribe that contra purchases must be carried out on the same market day on which a RSS has been executed.
Although every RSS must be underpinned by a SBL Agreement, the right to contra purchase the relevant security means that it is not necessary for each short sale to be settled through the use of borrowed securities.
Short selling is a common feature of most developed capital markets. The re-introduction of regulated short selling adds depth and variety to the local bourse.
Jessie Tan Shin Ee