Hedge fund practitioners react angrily to EU short-ban plans
In March, the European Parliament imposed some of the harshest restrictions yet on short selling. These measures have angered hedge fund managers, whose investors say some strategies will become unworkable, while academics claim the measures will hinder global trade.
They form part of a wider corralling of hedge funds by Brussels, which will regulate Europe’s alternatives industry under the Alternative Investment Fund Managers (AIFM) directive from 2013.
The latest proposals on short selling are not part of the AIFM, and must be agreed by member states before they become law, which is expected to be next year. They will be overseen by the European Securities and Markets Authority, which wins emergency powers temporarily to curb shorting.
Under the proposals passed by the Parliament’s Monetary and Economic Affairs Committee on 8 March, funds may not short EU government debt without holding countervailing long positions in it, and must tell regulators when individual net short equity bets hit 0.2% of a company’s shares.
Surprisingly, the proposals did not, as initially proposed, force public disclosure of net equity shorts at 0.5%, and they give funds one day’s grace to cover short bets.
Market fearsThe European Commission says regulators fear naked shorting debt can lead to mispricing and, in extremis, downward price spirals.Regulators must ascertain levels of shorting to maintain orderly markets.
The new rules follow the worldwide bans on shorting financial shares, enacted in September 2008, and on EU sovereign debt thereafter.
However, Robert Mirsky, head of hedge funds at KPMG (pictured), argues that hedge funds “are not angels of death; they are often looking for strong long trades, not just for shorts, and they can ramp up long positions with leverage”.
According to French business school EDHEC, banning uncovered shorts on debt will complicate hedging against default risk for entities that do business with sovereign nations. Potential financiers of these entities may shy away as a result.
“At a time when public/private partnerships and private financing of public infrastructure projects are considered one of the drivers of global growth, making it harder to manage country risk may at the very least increase the costs of these partnerships and this financing,” EDHEC says.
In any case, regulators will be unable to verify which long positions are offsetting Credit Default Swap (CDS) hedges. EDHEC’s opposition has found unexpected support from car manufacturer Volkswagen, which uses CDS to hedge country risk inherent in its business.
Andrew Baker, chief executive of hedge fund trade body the Alternative Investment Management Association (AIMA), says: “Debt markets will be less efficient, liquid and transparent. The cost of borrowing would increase and the availability of credit to borrowers would decrease, with a concomitant negative impact on growth and jobs.”
Jiří Król, director of policy and government affairs at AIMA, says: “Regulation should not prescribe the reasons why ine may wish to enter into a particular derivatives contract.”
Among other provisions, a fund’s banker must find and reserve instruments to lend it before the fund can sell the security to initiate the short trade. Król calls this “overly burdensome and makes some hedge fund strategies difficult, if not impossible, to pursue.
“It would disrupt the market terribly and will be nearly impossible for people to do that, especially for some fast-paced trading strategies.” One banker says the so-called ‘hard-locate’ provision would increase trading costs and widen spreads, although it would not make life impossible for fast traders, even those that file hundreds, or thousands, of trades daily.
But Tim Gascoigne, head of global portfolio at HSBC Alternative Investments, which has $28bn invested in hedge funds, says: “If that sector finds it difficult to generate alpha in certain markets, those managers will stop operating those kinds of strategies.”
HSBC AI has minimal exposure of about 2% to fast-trading managers. “Net-net, this will be positive for the industry, because it will decrease the perception hedge funds are risky entities,” Gascoigne says.