Regulate short selling to tackle market manipulation

I REFER to the recent Business Times report on the conviction of a man who fraudulently induced others to trade (“Set up a Telegram chat group to trade shares? You may run afoul of the law”, BT, Oct 11). It can be reasonably deduced that the inducement was aimed at luring investors into a particular stock in order to profit by shorting that stock when it had reached a certain level.

A longer-term and more effective measure to deter such acts is for the equities market to possess an innate ability to naturally weed them out.

An ecosystem that continuously and judiciously balances opposing views for price discovery contributes to this ability. Currently, the system distorts and disrupts price discovery because it does not balance the costs of shorting with the costs of buying, thus tilting forces in favour of shorting. The problem is not short selling but the absence of a level playing field.

When investors buy, they must pay, or sell the shares they had bought if they do not wish to pay, all within a short time frame. This means buyers must take delivery. When short sellers sell, they do not need to deliver the shares sold if they buy back what was sold from the market before the end of the trading session. The key lies in delivery.

While the rationale of investors buying without the means to pay should apply equally to those selling without the shares to deliver, and hence make this matter a non-issue, in reality, broking firms (and hence the trading system) impose curbs on buying without funding while no such checks exist on selling without the means to deliver. This imbalance has tilted the market in favour of shorting and has in the past worked to devastating effect in destroying shareholders’ wealth and overall confidence in the market’s ability to protect the interests of all parties.

When market conditions are placid with low volatility, such intra-day shorting is rarely an issue. The freedom to sell without having to deliver becomes a problem in times of extreme stress for a listed company. The stage is then set for predatory short operations. The buying quickly disappears, sometimes exacerbated when trading firms impose ad hoc buying curbs. Short sellers, however, can short with impunity as there is no need to deliver the shares shorted as long as they buy them back by the end of the trading session.

In such situations, even though there is a finite number of shares issued by a listed company, the supply of shares offered for sale can be practically infinite, overwhelming demand and making the share price plunge.

Over the years, this consistent imbalance has hurt the market by wiping off liquidity. While no system guarantees profit, whether in going long or short, what is not needed is a system that inadvertently favours shorting. Such a system can also destroy listed companies. Markets are reflexive in nature and as liquidity affects valuation, and valuation impacts fundamentals – which in turn hits valuation and liquidity, setting up a vicious circle. Hence, companies here that can delist, do so, and others avoid listing in Singapore.

The problem can be solved by levelling the playing field through mandating that just as buyers must take delivery, sellers must deliver. This means that when someone sells, he must already have the shares in hand or borrow first if he does not. This change can make a big difference to curb manipulation.

Tng Kim Bock