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Corporations Amendment (Short Selling) Bill 2008 Parliament of Australia Department of Parliamentary Services Parliamentary Library Information, analysis and advice for the Parliament BILLS DIGEST www.aph.gov.au/library 25 November 2008, no. 65, 2008–09, ISSN 1328-8091 Corporations Amendment (Short Selling) Bill 2008 Kali Sanyal Economics Section PaoYi Tan Law and Bills Digest Section Contents Purpose .............................................................. 2 Background ........................................................... 2 Global financial crisis ................................................. 2 What is short selling? ................................................. 4 Why Short? ....................................................... 6 For speculation .................................................... 6 For hedging ...................................................... 6 Why does short selling reduce share prices? ................................ 6 Current regulation .................................................... 7 Australia’s Response to Short Selling ..................................... 7 Recent Global Regulatory Response ...................................... 8 Committee consideration .............................................. 10 Financial implications .................................................. 10 Key issues ........................................................... 11 Impact of ban on short selling in Australia ................................ 11 Position of significant interest groups/press commentary ...................... 11 Main provisions ....................................................... 13 2 Corporations Amendment (Short Selling) Bill 2008 Corporations Amendment (Short Selling) Bill 2008 Date introduced: 13 November 2008 House: House of Representatives Portfolio: Treasury Commencement: Schedule 2 of the Act commences on the 28th day after the day the Act receives the Royal Assent. Schedule 3 commences on a day to be fixed by Proclamation, or 12 months after Royal Assent, whichever occurs first. The remainder of the Act commences on the day the Act receives Royal Assent. Links: The relevant links to the Bill, Explanatory Memorandum and second reading speech can be accessed via BillsNet, which is at http://www.aph.gov.au/bills/. When Bills have been passed they can be found at ComLaw, which is at http://www.comlaw.gov.au/. Purpose To give effect to three key measures: • to clarify ASIC’s powers to regulate and ban short selling of financial products • to amend the Corporations Act 2001 (the Corporations Act) to prohibit naked short selling, and • to increase disclosure requirements related to covered short sale transactions. Background Global financial crisis The immediate genesis of the current global financial crisis occurred around the end of 2004 with a spike in loan delinquencies in the United States. This spike was triggered by the federal funds target rate (the US equivalent of the Reserve Bank of Australia’s cash rate target) increasing from 1 per cent in mid-2004 to 5.25 per cent by mid-2006, where the rate stayed, until September 2007. The problem of rising housing defaults did not manifest itself immediately (the US mortgage market is substantively different from Australia’s, with a much heavier reliance on fixed-rate mortgages and adjustable-rate mortgages, rather than variable rate mortgages). Warning: This Digest was prepared for debate. It reflects the legislation as introduced and does not canvass subsequent amendments. This Digest does not have any official legal status. Other sources should be consulted to determine the subsequent official status of the Bill. Corporations Amendment (Short Selling) Bill 2008 3 Due to innovations in securitization, the risks related to the inability of homeowners to meet mortgage payments have been distributed broadly, with a series of consequential impacts. The crisis can be attributed to a number of factors, such as the inability of homeowners to make their mortgage payments due to rising adjustable mortgage rates; poor judgment by either the borrower or the lender (or both), and inappropriate mortgage incentives. Further, declining home prices have made re-financing more difficult. Since the end of 2007, what began as a bursting of the U.S. housing market bubble and a rise in foreclosures had ballooned into a global financial crisis. Some of the largest and most venerable banks, investment houses, and insurance companies have either declared bankruptcy or have had to be rescued financially. In October 2008, credit flows froze, lender confidence dropped, and one after another the economies of countries around the world dipped toward recession. The crisis exposed fundamental weaknesses in financial systems worldwide, and despite coordinated easing of monetary policy by governments and trillions of dollars in intervention by governments and the International Monetary Fund, the crisis continues.1 Policy-makers around the world have responded to these developments in a number of ways. Central banks have been adding liquidity to their financial systems, and they have been cutting official interest rates. Some governments, including Australia, have announced substantial fiscal stimulus packages. Governments around the world have taken direct measures to strengthen their financial systems, including capital injections, enhanced protection for retail deposits, and the offer of guarantees to various types of wholesale lending. These steps should help to stabilise conditions over time, but sentiment is still fragile.2 In net terms, US equity prices have fallen by around 30 per cent since the Lehman Brothers’ collapse (15 September 2008) and the Australian market is down by 25 per cent over the same period.3 From their 2007 peak, the US S&P 500 Index is down by around 40 per cent and Australia’s ASX 200 Index is down by almost 50 per cent. Coupled with declining trends in several other economic indicators, these developments led experts to believe that Australia would expect a contraction of the economy and a higher rate of unemployment in the coming months. Reserve Bank of Australia stated: With the ongoing stresses in financial markets, it is possible that the deterioration in the external environment could continue. Even if this did not occur, the effects 1 US Congressional Research Service (CRS) Report: ‘The U.S. Financial Crisis: The Global Dimension, with Implications for U.S. Policy’, November 18, 2008. 2 Malcolm Edey, Assistant Governor (Economic), Reserve Bank of Australia, ‘The Economy in Late 2008: Conditions and Prospects’, speech presented at the Australia & Japan Economic Outlook Conference 2008, Sydney, 19 November 2008. 3 ibid. Warning: This Digest was prepared for debate. It reflects the legislation as introduced and does not canvass subsequent amendments. This Digest does not have any official legal status. Other sources should be consulted to determine the subsequent official status of the Bill. 4 Corporations Amendment (Short Selling) Bill 2008 on domestic activity of the deterioration that has already occurred could be deeper or more persistent than expected in this outlook. In particular, a more rapid unwinding of the resources boom than (sic) has been assumed would have significant negative effects throughout the economy, resulting in softer growth in domestic incomes and spending... 4 Against this backdrop of chain of events, the Australian Government has embarked upon a series of measures so as to contain the fallout of the crisis in the financial markets. The restriction and tightened regulation of short selling on the stock exchange is one such measure. What is short selling?5 When individuals invest in shares they will generally want to ‘buy low and sell high’, that is, they purchase shares which they expect will go up in price. This is known as ‘buying long’, as any profits will be delivered down the track. ‘Short sellers’ do the opposite. They want to gain from a fall in price, so they are looking for shares they think will go down in price. Unlike other share traders, short sellers do not own the shares they sell. They sell them hoping that the price will fall before they have to hand over shares in settlement of the sale. In a conventional short sale, the investor – usually a hedge fund or large investment bank – takes the view that shares in a particular company are set to fall. The investor then borrows shares in that company from someone who does own them. Most often the owner will be a large pension fund or insurance company. The investor then sells the shares in the market. Once the shares have fallen in value, the investor buys them back at the lower price and returns them to the original owner. If all goes according to plan, the investor will pay less to buy back the shares than they received for selling them. There are some costs involved, notably that the lender of the shares charges a fee for loaning out the shares. However in a market where the price of the particular shares is dropping the short seller can still make a profit. The chart below6 provides an example of how short selling works. There is a share valued at $5.00 which the short seller thinks will go down in price. On day 0 the short seller enters into a contract to sell that share for $5.00. 4 ibid. 5. The material in this heading is from Australian Securities and Investments Commission: financial tips and safety checks, available at: http://www.fido.gov.au/fido/fido.nsf/byheadline/Short+selling+- +what+is+it+anyway%3F?openDocument [accessed on 25 November 2008]. Warning:
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