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EU regulation fear causes hedge funds to shun short selling

Wednesday, June 15, 2011
Opalesque Industry Update – The looming European Union regulation that requires funds to disclose their short positions are causing hedge funds to shun short selling which could compel pension funds to again retract from securities lending, International Securities Lending Association (ISLA) Chief Executive Officer Kevin McNulty told reporters during a press conference on Tuesday.

A report quoted McNulty as saying: "Hedge funds like to have a level of certainty on their ability to execute and live with a trade for some time. Short-selling is good for markets while artificially stopping short-selling is a bad thing.”

ISLA represents banks, pension funds, insurance companies and agents that either lend out securities or facilitate the activity. Its biggest borrowers are hedge funds.

Because of the looming European regulation, borrowings from short sellers fell to $1.8tln from $4tln before the global recession. Hedge funds are fearful that the new rule willl require them to publicly disclose their short positions but the biggest fear within the industry, is that the EU will permanently ban short selling.

According to a report by the Wall Street Journal, the European Union is finalizing details on a new rule that would require short-sellers, particularly hedge funds, to disclose their positions to both the market overall and to regulators. The same proposal also empowers authorities to ban the practice under certain conditions.

Several European countries, like the U.K., have already set their respective rules around short-selling. In the U.K., short-sellers are required to disclose their position in some financial stocks and in companies involved in rights issues once their position reaches a minimum of 0.25% of a company's share capital.

McNulty said during the press briefing: "The supply side of the business is pretty healthy. It's very much the demand that is not there right now, relative to where it was two to three years ago. Hedge funds like to have a level of certainty on their ability to execute and live with a trade for some time."

"We think if you require investors to name themselves, that can have some very negative effects in the market.

Also to be affected by the new rules are pension funds which will be tagged as short sellers under the proposed new European Union rule.

Pension funds have again expanded their lending programs to near the pre-crisis level, after most of them held back at the height of the global financial meltdown.

But McNulty warned that pension funds could retract their lending programs if they will be classified as short sellers because they lend out securities that they also sell. The new rule will expose lenders to stringent rules.

"We want to make sure investors do not end up with a situation where, if you're a pension fund that has loaned and then sold shares, you are not held to have sold [them] short. If there is a risk to pensions in being seen as short selling, they may not lend anymore,” McNulty added.
Precy Dumlao

See last week's related article:
Opalesque Exclusive: European regulatory update for hedge funds Source

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