Hedge fund rules give glimpse into a rich and murky world |
Date: Tuesday, June 24, 2008
Author: Tony Bonsignore , Citywire.co.uk
When equity markets were tumbling earlier in the year commentators appeared to find the perfect scapegoat to blame for the market's woes: the so-called ‘short sellers’. These are the investors – mainly hedge funds - who bet on share price falls by borrowing stock and then selling it at the current market price, hoping to buy it back later at a lower price before finally returning it to the lender.
Critics argue that these short sellers distort the equity market by putting deliberate downward pressure on certain share prices, as the very act of short-selling tends to force prices downwards as stock is unloaded on to on the market. Companies engaged in the process of raising money through rights issues are particularly at risk, it is argued, as it is simply too easy for short sellers to plant a negative rumour about that company in the market and then benefit from the subsequent fall in the share price.
Of course, it is argued, the share price will inevitably recover its value as investors realise that the rumours are untrue and that the stock has effectively been oversold. However, this will not help the company in question, whose rights issue has been unnecessarily imperilled by the short-term greed of the short-sellers.
It’s a powerful argument, and one that the FSA was duty-bound to take very seriously, especially after HBOS was seemingly pushed to the brink of disaster in the spring. Since then a number of companies – most notably banks – have embarked upon potentially tricky cash-raising exercises, fuelling fears that they are in serious financial trouble. Against this nervous backdrop any rumour is likely to make a serious dent in investor confidence.
It was with this in mind that the FSA announced on Friday 13 June that it was shortly to introduce new emergency disclosure rules for short sellers. The rules are hardly draconian – they only apply to short sales in companies actively engaged in rights issues, and even then only to positions worth more than 0.25% of the company’s value. But it was undoubtedly a first; the first time hedge funds would be forced to disclose their activities in a similar way to ‘long’ (ie regular) investors. For this increased transparency the FSA should be applauded.
Yesterday saw the first disclosures arising from these new rules, and they make for fascinating reading. As one would expect, the two UK banks under most pressure right now – Bradford & Bingley and HBOS – are the most under pressure from short sellers.
London hedge fund giant GLG currently has a short position against B&B worth some 4.14% of the troubled Yorkshire bank, closely followed by Tiger Global Management at 3.40%. In total, short sellers have waged around £60 million on the B&B share price going down the pan. The economy’s loss is the key to the hedge fund manager’s fortune, it seems.
HBOS, meanwhile, currently engaged in a vital rights issue, is pitted against New York-based Harbinger Capital Partners, who yesterday disclosed it had a short position against the bank worth some 3.29% of its market value. Overall, it was revealed, short sellers had sold some £400 million worth of HBOS stock in recent weeks and months, a factor which has done much to push HBOS’s share price down below the critical 275 p mark – the level at which it has pitched its rights issue.
Other companies, meanwhile - including under-pressure newspaper group Johnston Press – have also been attacked by the short sellers just as they have looked to raise much-needed cash. Overall, it is an intriguing insight into the battle of wills between company management and highly paid and ruthless hedge fund managers, people who will do anything pretty much anything to earn their wedge of cash. And with hedge fund fees typically in the range of 20% of overall profits, these managers have every incentive to bring these companies to their knees.
The FSA has always supported the concept of short selling and steadfastly refused to ban it outright, and this position is surely right if the regulator and investors still consider theirs a ‘free market. However, what the FSA has now finally challenged is the veil of secrecy under which hedge fund managers have been able to operate, a privilege regular investors are (quite rightly) unable to enjoy. Let’s hope the regulator decides against repealing these rules once the current panic subsides, and maybe even goes further it creating a real level playing field for all investors.
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