Short-sellers could be faced with increased scrutiny when targeting European companies following the GameStop furore in the US, according to top European regulators.
In Europe, short-sellers already have more regulatory hurdles to overcome than they do in the US. Many European countries, for example, require investors to notify regulators of any short position making up 0.5% or more of a company’s stock. European Commission director for financial markets Ugo Bassi has said that the executive branch may consider tweaking the rules to create even more transparency.
“We could envisage, for example, to reduce the threshold to ensure that these disclosure obligations are triggered before” the 0.5% level, he said at a 23 February meeting of the European Parliament’s committee on economic and monetary affairs.
Alternatively, the body may “impose disclosure not only towards the regulator but also publicly” at least once a week or once every fortnight.
“The more we bring everything into the light, and in particular short-selling… that could possibly help,” he said.
Equity markets have been upended by a surge in retail investing, fueled in part by social media platforms such as Reddit and free-to-trade sites such as Robinhood. An online campaign among retail investors to punish investors who were short GameStop shares led the stock to skyrocket over 2,700%. Investors caught on the wrong side of the trade, such as Melvin Capital, Point72 and Citron Research, lost millions on their short bets.
The market mania has ignited a debate about the role of short-selling in capital markets, and in the US, the Securities and Exchange Commission is weighing how to impose more transparency on bearish trades in light of the GameStop incident.
But market participants in Europe have recently had reasons to look at short-selling in a more positive way — the alleged fraud of German payments company Wirecard, which collapsed last year, was brought to light in part by short sellers.
One short-seller and early critic of Wirecard cast doubt on the usefulness of added regulation on shorts.
“We hope [European regulators’] focus will cover sell-side analysts who blatantly work hand-in-hand with bad companies to inflate share prices,” said short-seller Fraser Perring at Viceroy Research. “These cosy relationships need investigating as they have gone on for too long with relaying the company’s rhetoric, despite obvious failings.”
European short position levels are lower than in the US, which “limits the risk of a GameStop-style short squeeze” in Europe, said European Securities and Markets Authority chair Steven Maijoor at the same event.
“In the European market, these communities of retail investors are still mainly along national borders, national geographies,” Maijoor said. “The purchasing power of these retail investors is much less, making it more difficult to move prices.”
“I cannot agree more that in some cases, short-selling can be very important and can help markets work well,” he added. “In the Wirecard case, there were short-sellers that had an incentive to get the accounting fraud to the surface.”
Neil Campling, one of the only sell-side analysts to call Wirecard a zero amid a sea of buy ratings, said making shorting easier, not harder, would do more to strengthen stock markets and prevent future Wirecards.
“We have clients who were unable to short-sell Wirecard based on very illiquid, sudden disappearance of stock available for borrow, because of nose-bleed borrowing costs or because of the decision to ban short-selling of the stock, or a combination of all three,” Campling told FN. “So, actually, it wasn’t the structure of the market that helped uncover the Wirecard fraud… in fact the inefficiencies of the structures helped prevent the discovery process for quite some time.”
“The result was that many retail investors in Europe lost money,” he said. “Who is to blame for that?”
Not all were as sceptical of more scrutiny on short-sellers.
“It does seem that more transparency on US short disclosures side would have led to less violent share price moves especially, in GME,” said Ivan Cosovic, founder of short-selling research firm Breakout Point. “Retail investors were partly acting on wrong assumptions about the short interest around the end of January.”
When it comes to GameStop, the stock continues to soar. GameStop shares have resumed their upward trajectory, soaring more than 100% on 24 February, while short interest in the stock has subsided.
“We welcome more transparency, Europe has been [the] leader when it comes to short-selling disclosure transparency,” Cosovic added. But, he said: “One shouldn’t discount probability of a GameStop-like event in Europe.”