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Few issues in the Canadian capital markets are as divisive as short-selling. Earlier this year, the Canadian Investment Regulatory Organization (CIRO) launched a consultation on proposed changes to the trading rules that aim to stiffen short-selling regulations. The proposals primarily beef up provisions requiring traders to have a “reasonable expectation” before they enter an order that they will be able to settle short trades on time. The proposals add supervisory obligations that back up that requirement.

These latest proposals were put forward in the wake of repeated efforts to examine complaints about abusive and predatory short-selling. To some players, particularly certain junior resource companies, there’s no bigger threat to Canadian markets than short-selling, with — in their view — its weak regulation relative to the U.S.and woefully inadequate enforcement. Yet, many other players in the securities industry feel the existing rules are just fine.

These starkly different views were highlighted when CIRO’s predecessor, the Investment Industry Regulatory Organization of Canada, and the Canadian Securities Administrators (CSA) reviewed short-selling in 2022. They concluded there was “no consensus on the appropriate regulatory regime for short-selling.” Regulators nevertheless committed to continuing to study the issue and considering policy action.

Those efforts led to CIRO’s latest proposal for toughening up pre-trade settlement expectations. Predictably, the reaction is sharply divided.

To many in the investment industry, the reforms are unnecessary and unwanted.

The Investment Industry Association of Canada’s (IIAC) submission argued the existing regime for policing short-selling is fine, and any changes would add costs without generating benefits.

“The proposals appear an attempt to solve a problem that currently does not exist on the Canadian marketplace,” the IIAC said. It noted that most dealers see relatively few failed trades, and the trades that do fail are generally due to administrative reasons rather than abusive or manipulative trading behaviour.

Imposing new obligations on firms and traders to confirm they’ll be able to settle a trade before entering an order “creates a substantial new burden for IIAC member firms, without CIRO presenting clear evidence of pressing issues that could not be addressed under the existing regime,” the group said.

The IIAC also suggested that imposing these obligations on the industry on behalf of their direct access clients could slow trade execution and add operational complexity and costs without necessarily enhancing market integrity.

The exchanges expressed similar concerns.

TMX Group Ltd.’s submission said the proposed reforms could have a “detrimental effect” on both industry firms and issuers by curbing trading activity and driving traders out of the market.

The firm said that, since the regulator published its proposals, it has “received unsolicited feedback from numerous market participants” who are concerned about the possible impact of the changes, which would be unique to the Canadian market and “may impose a significant financial and administrative burden on them.”

Given these concerns, TMX Group said the proposed changes “may have the chilling effect of deterring trading activity in Canada from the international buy side as a whole (rather than targeting those engaged in failed trades), ultimately negatively impacting issuers in Canada.”

If regulatory action to address the problem of failed trades is necessary, TMX Group suggested using the existing short-selling rules or considering other reforms to that regime.

Another faction of the market calls abusive short-selling a serious problem.

CNSX Markets Inc., which operates the Canadian Securities Exchange, said the belief in this problem has “infiltrated the conversation of the broader trading community and has become a leading topic of nearly all of our stakeholder conversations involving trading and equity markets in Canada.”

Save Canadian Mining, an advocacy group for junior miners, insisted in its submission that the problems with short-selling in Canada are severe and require drastic action. The group was intensely critical of CIRO’s efforts, characterizing the proposals as “a distraction that looks like CIRO is doing something when, in fact, the core issues are left completely as is.”

The group has asked the federal government for a ban on all naked short-selling, along with an audit of failed trades and alleged spoofing activity at the banks.

Save Canadian Mining also reiterated the 2020 recommendations it made to Ontario’s Capital Markets Modernization Taskforce, which called on regulators to implement much tougher rules regarding short-selling, including strict pre-borrow requirements, mandatory buy-in requirements, tougher short-position disclosure and more stringent oversight.

The group also seeks a ban on certain high-frequency trading tactics. “In our view, we have major problems in Canada, and we need immediate and decisive action,” Save Canadian Mining said.

The Capital Markets Modernization Taskforce’s final report echoed some of those sentiments, and it concluded that rules around short-selling are not tough enough. The report recommended reforms such as adopting stricter pre-borrow and mandatory close-out requirements, along with banning short-selling in new issues.

The task force also recommended policymakers prohibit making misleading statements about companies, which would enable provincial regulators to take action against efforts to move stock prices with misleading information in order to combat both so-called short-and-distort campaigns and pump-and-dump schemes.

However, the consultation on CIRO’s modest proposals reveals that support persists for broader reforms.

CSNX’s submission said that, while it endorses CIRO’s latest proposals, it believes mandatory close-out requirements are needed to properly combat abusive short-selling and correct the perception that this activity is endemic in Canadian markets. CSNX said it has considered adopting mandatory close-out requirements in its trading rules, but concluded that more comprehensive regulation is needed.

The Prospectors & Developers Association of Canada (PDAC) also said it supports CIRO’s proposals, which it said will reduce the risk of manipulative short-selling. But tougher enforcement of the existing rules is also required to deter abusive trading, it said, and action is needed to address misinformation and social media use by manipulative short-sellers.

Specifically, PDAC called on CIRO and the CSA to address the use of social media in abusive trading campaigns, to adopt an “alternative uptick rule” to guard against runaway short-selling, and for tougher disclosure requirements on brokers that lend clients’ securities to short-sellers.

This article appears in the May issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.