This article appears in the April 2023 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.
After an industry task force in Ontario called for tougher rules regarding short-selling, the latest regulatory consultation on the issue shows strong resistance to any notion that there’s a problem.
In a final report released in early 2021, Ontario’s Capital Markets Modernization Taskforce recommended regulators beef up short-selling rules, citing concerns that Canada’s regime is weaker than the requirements in both the U.S. and Europe. The task force said regulators should tighten pre-borrowing requirements and impose a mandatory buy-in provision for short trades that fail to settle. The report also called for curbs on short-selling in connection with new offerings.
A joint consultation by the Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organization of Canada (now part of the new SRO) explored these issues in a joint consultation that closed in mid-March.
The investment industry resisted the basic premise that short-selling regulation in Canada needs to be tougher and opposed specific recommendations for reforms, such as stricter pre-borrowing requirements, mandatory buy-ins and increased disclosure of short-selling activity.
The Investment Industry Association of Canada (IIAC) said in its submission that its members don’t believe “a material problem associated with short sales currently exists in Canada.”
Beefing up pre-borrowing requirements would disrupt investors’ ability to short securities, harming price discovery and market quality while also imposing “large operational costs on Canadian dealers,” the IIAC said.
The association also questioned the existence of a problem that would be solved by introducing mandatory buy-in requirements. Most trades that fail do so because of administrative or operational issues, it said, not due to abusive trading behaviour.
The IIAC’s resistance was echoed on the buy side, with industry groups such as the Portfolio Management Association of Canada (PMAC) and the Alternative Investment Management Association (AIMA) both pushing back on proposed reforms.
PMAC’s submission urged the regulators to hold off on changing the existing regime: “There does not appear to be sufficient data, evidence or rationale to support changes to the current regulatory framework.” Any policy changes “should be based on data and evidence rather than perception.”
The demand for tougher rules is coming from certain issuers, particularly junior issuers that believe they’re suffering at the hands of predatory short-sellers.
According to CSNX Markets Inc., which operates the Canadian Securities Exchange, widespread concern about abusive short-selling exists among the issuers on its market: “We can state with certainty that it is an article of faith among the leadership group of the CSE’s issuers and the parts of the trading community focused on the early stage company market that abusive short-selling is a feature of the Canadian equity capital markets. Whether this sentiment is backed by specific evidence or not, the belief is a common one.”
For industry firms, though, unsubstantiated beliefs aren’t an adequate basis for policy changes.
The submission from the Canadian Security Traders Association Inc. (CSTA) stated short-selling is already riskier than long buying, since shorts have negative carry and “the potential for infinite losses.
“The threshold for change should be high,” the CSTA said. “Any rules or regulations that further discourage short-selling need to be supported by overwhelming evidence.”
Industry players worry that deterring short-selling based on a perceived problem would have real negative effects on markets.
PMAC pointed to potential unintended consequences, such as decreased liquidity, increased trading costs, loss of information to the market and price uncertainty.
PMAC’s members are worried that specific reforms, such as tightening pre-borrowing requirements, “would slow execution, increase turnover in short-selling activity in general, and create a chilling effect on legitimate and essential short-selling activity,” the submission stated.
In addition, these measures wouldn’t necessarily address the perceived problem of abusive “short-and-distort” campaigns, PMAC argued.
Other groups expressed concern about increasing disclosure requirements for shorting activity.
The Canadian Advocacy Council of CFA Societies Canada (CAC) warned that increasing public transparency of short-selling and short positions could discourage short-selling, harming price formation and the capital markets.
“We remain concerned generally that potential policy responses to perceived issues will have unintended and unwanted consequences,” the CAC submission said. It’s not appropriate “to propose new disclosure requirements on short-selling in Canada” without evidence to justify such a move, it added.
The prospect of changes to short-selling rules also is complicated by the planned shift to a reduced settlement cycle, with both the U.S. and Canadian securities industries planning to move to trade day plus one (T+1) settlement in May 2024.
“Changes to Canada’s short-selling regime at this time would conflict with extensive industry efforts to shorten the settlement cycle to T+1, which we expect would increase settlement challenges,” said Scotiabank Global Banking and Markets in its submission to the consultation.
The bank suggested that altering short-selling rules and settlement practices at the same time would make isolating the effects of these changes difficult, “and make it difficult to understand the appropriate regulatory approach to short-selling in a T+1 environment.”
TMX Group Ltd.’s submission echoed that concern. Regulators should not contemplate introducing mandatory buy-in requirements until “after the migration of the T+1 settlement cycle has been completed and the market has adjusted,” it said.
“Imposing a mandatory buy-in requirement in advance of this significant process change could have unintended negative consequences on the Canadian capital markets,” TMX warned.