Short-Selling Hedge Funds in the Firing Line Again as Stock Markets Crash ; BUSINESS ANALYSIS Critics Claim London Market Provides Too Liberal an Environment for Short Traders
Cope, Nigel, The Independent (London, England)
AS STOCK markets continue to tumble, the search for someone to blame intensifies. Currently in the firing line are short sellers, who sell shares they do not own in the hope of buying it back more cheaply later on. Typically hedge funds, short sellers are blamed for driving prices down and increasing market volatility. They are the market's bad boys of the moment.
David Prosser, chief executive of Legal & General, has started a campaign against short selling, saying it disadvantages long-term savers. He is also proposing a tax on the practice as a means of discouraging it.
Yesterday saw David Varney, chairman of the mobile phone network operator mmO2, wade into the debate. Lambasting the "woeful adequacy" of the disclosure rules relating to short selling, he urged more stringent regulatory procedures. "Many in the markets and industry believe aggressive short selling is damaging interests of long-term investors," he said.
Mr Varney said that in the eight months since mmO2's demerger from BT, more than 1.6 times its shares in issue had been traded in London. This was despite little change in its shareholder register. "The obvious implication is that the shares have been lent to hedge funds and other institutional traders to enable them to trade," he said.
But are short sellers really responsible for the precipitous fall in share prices? Or are they more a symptom than a cause? And is there a hidden business agenda behind some of the stances taken on this controversial issue? For example, Legal & General stopped stock lending after the 11 September tragedy as a means of trying to starve hedge funds of the shares they need to sell short. But rivals, such as Barclays Global Investors, continue to offer the service as it generates fees. In theory, this would enable Barclays Global's huge Aquilla tracker fund to undercut L&G's trackers with lower fees.
In 1990 the total capital under management of hedge funds was less than $20bn (pounds 13bn), says Hedge Fund Research in Chicago. Earlier this year the amount had mushroomed to $600bn. The growth has been fuelled by the greater fees that can be generated from hedge fund management. Falling markets have also increased the attractions as hedge funds can sell short as well as "go long" (ie buy shares with a view to them rising over the long term. Conversely most traditional pension funds operate long-only positions and cannot sell short).
The criticisms of hedge funds are legion. They are accused of poor disclosure, limited regulation, favourable tax treatment from registering their operations offshore and exacerbating downward movements in shares. The collapse of Long Term Capital Management in the US in 1998, which sparked a global financial crisis, gave hedge funds an image problem that has been hard to shake off.
The conflicts of interest are huge. If an institution lends stock to a hedge fund, it is likely to receive back a parcel of shares worth less than before. How is that in the best interests of pension fund investors?
And the bulge-bracket investment banks are currently doing vast trades with hedge funds (often more than 50 per cent of their business). How does that service square with the services they are providing to traditional pension fund clients? …