The Securities and Futures Commission (SFC) is introducing new disclosure requirements for short positions in certain Hong Kong listed shares.
Background
Part XV of the Securities and Futures Ordinance (Part XV) requires disclosure of short positions of over 1% held by substantial (5% or more) shareholders in a listed company, and of all short positions held by directors and chief executives of listed companies.
Market information:
- All permitted short sale orders on the Stock Exchange are required to be disclosed as such. The Stock Exchange reports aggregated short sales in each stock twice daily. Only certain "designated securities" are eligible for short selling.
- Market participants in the Hong Kong futures and options markets are required to report futures and options positions (in respect of most traded contracts) in excess of prescribed reporting levels.
Along with a number of authorities worldwide, the SFC has implemented enhanced disclosure requirements for short positions. They are intended to give greater clarity into overall market activity, in particular at times of crises when high volumes of short selling are viewed with concern. After a series of consultations, these requirements are now reflected in the Securities and Futures (Short Position Reporting) Rules. Generally, the Rules appear to have reached a sensible balance of conflicting requirements, and a lot of market comment has been taken on board.
The new requirements
Weekly reporting of net short positions in certain shares is to be introduced with effect from 18 June 2012.
"Reportable" short positions in certain shares through the cash market are to be calculated as at the end of the last Stock Exchange trading day of each week, and those positions at or over the reporting threshold are to be reported to the SFC by the second business day of the next week.
The SFC has the power to require next-day reporting in respect of each Stock Exchange dealing day in the event of emergencies.
The short positions are to be reported net of shares beneficially owned. This was introduced late on as a result of lobbying and is hugely beneficial for lightening the burden of the regime.
Off-market positions and short positions through derivatives are not relevant for these purposes. Disclosures are to be made on an individual-entity basis, with no aggregation within groups, but with special provisions relating to trusts, partnerships and funds.
The SFC will not disclose individual positions but will publish aggregated per stock information on short positions.
This makes for a relatively simple regime which will have limited application in practice to major long-term shareholders, long-only funds and others who conduct small-scale short selling activities. Hedge funds, traders and the like, though, need to get well acquainted with and develop reporting systems for these requirements. There is some fear that this regime could push shorting activity to the derivatives or OTC markets.
- "Reportable short position" means, in essence, a net short position (i.e. after offsetting long positions beneficially owned) as a result of on-market sales equal to more than the applicable threshold, which is the lower of:
- 0.02% of the relevant company's issued share capital, and
- a value of $30 million.
"Short position" means the position in relevant shares that a person has as a result of selling the shares at or through the Stock Exchange or by means of any one or more specified automated trading service (of which there are currently none) where:
- at the time of each sale comprised in the position, the person did not have a presently exercisable and unconditional right to vest the shares in the purchaser; or
- each sale comprised in the position was the subject of a short selling order (i.e. the sale will be settled with borrowed shares (already received or confirmed as available for use) or shares to be delivered on the exercise of an option, convertible or the like).
This definition involves complexities as to when short positions can be said to have ceased.
- Relevant shares: The reporting requirements will initially apply to constituent stocks of the Hang Seng Index and Hang Seng China Enterprises Index and other "financial stocks" (as classified by Hang Seng Indexes Company) which are permitted for short selling by the Stock Exchange.
The SFC has said that these are 100 stocks (accounting for around 70% of market capitalisation as at the end of 2009). These are a narrower category than the "designated securities" which are permitted for short selling by the Stock Exchange. This represents a focus on those shares whose performance is more likely to affect market stability.
- Who reports - non-aggregation: Persons with reportable short positions are required to report those positions. This is to be done on an individual-entity basis, and there is to be no aggregation within groups.
Funds/their managers: Funds are to report on a per fund basis. Investment managers may not aggregate the short positions under their control. Indeed, investment managers are not expected to report short sales conducted by them for clients - that is the clients' obligation on the basis that they are the "owners" and best placed to know their total net positions.
Positions of a company attributable to a particular collective investment scheme are to be treated separately and not aggregated with those attributable to other collective investment schemes. Consequently, in the case of an umbrella fund structured as a single corporation, the corporation may have separate reporting obligations with respect to each of the sub-funds. Short positions are to be reported net, but there is to be no netting of short and long positions between different sub-funds.
There is no provision enabling an owner of managed accounts to treat each of the managed accounts separately for disclosure purposes. Consequently, an investment manager of a segregated account mandate may be unable to assume the reporting obligation for its clients (even if it is willing to do so), as the investment manager will not necessarily know a client's overall holdings.
Trusts: If a reportable short position in any specified shares is held on trust, the duty to notify does not apply to a beneficiary of the trust and instead applies to the trustee of the trust as if that person were the beneficiary. The intention appears to be that a trustee's positions as trustee are to be treated separately from and not aggregated with his other positions - this provision makes no sense otherwise.
Partnerships and other joint owners: Short and long positions attributable to different partnerships are to be treated separately and not aggregated. The scope of this provision is unclear but it appears to be implicit that a person's partnership positions are to be treated separately and not aggregated with his other net short positions.
The problem of duplication of disclosures by joint owners (other than partners) is not resolved by these provisions. But it appears that FAQs or guidance will provide that a designated joint owner may report on behalf of all joint owners.
Different trading units/books: "To enable those market participants whose trading activities are conducted on a trading unit/book basis to leverage on their current trading infrastructure for short position reporting", the SFC has said it will issue guidelines showing how to report the sum of the net short positions across different trading units/books, without netting off long positions against different trading units/books.
This appears to be optional, but the SFC has stated that "market participants who choose to determine their reportable short positions [in this way …] will in fact submit themselves to stricter requirements. [This approach], which precludes netting of short positions against long positions across trading units/books, will increase the chance of a market participant's short position [in one pool] hitting the reporting threshold." On the other hand, being able to divide short positions between pools will reduce the levels of short positions in each pool, and thus be likely to reduce the need for disclosure.
- Method of reporting: Reporting must be in a form specified by the SFC and submitted electronically. The SFC has issued draft disclosure procedures and proposed templates.
- Criminal penalties, knowledge and "reasonable excuse": Despite strong objections during public consultation, a breach of the reporting requirements should constitute a criminal offence, with the same maximum penalties ($100,000 fine and two years' imprisonment) as under the disclosure of interests regime in Part XV. The SFC has, however, added that the contravention must be without reasonable excuse, which adds very significant protections in practice.
Knowledge: Under the short position reporting regime, unlike under Part XV, the reporting requirement will arise irrespective of a person's knowledge of that position. In some situations, a person with a reportable short position will not immediately know about it – such as in the case of the owner of a segregated account managed by an investment manager. A genuine, fault-free, lack of knowledge might well constitute a "reasonable excuse", but this is by no means clear where there is an element of negligence or other culpability. A person who has appointed an agent to transact on his behalf, for example, but not imposed procedures to keep him promptly informed of transactions, may well fail the "reasonable excuse" test.
- Disclosure by agent: Agents (including investment managers) may be authorised to report on behalf of short sellers, but the sellers will remain legally responsible for disclosure. It is uncertain whether the owner could establish a "reasonable excuse" defence in the event that an agent fails properly to report his positions - although, if the owner could show that he has taken all reasonable steps to secure proper disclosure by the agent, and the agent's failure was not in any way the fault of the owner, this must be likely to constitute a "reasonable excuse". Owners should therefore document the steps they take in this regard.
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