Bursa Malaysia Bhd has announced that it will bring regulated short-selling (RSS) back to the Malaysian stock exchange this month. The move comes after an eight-and-a-half year ban on the practice, and is aimed at boosting liquidity and attracting foreign investors.
Bursa CEO Yusli Mohamed Yusoff said that the exchange was conducting some final testing and, upon completion, short-selling would be launched.
The bourse abandoned RSS in an attempt to halt a speculative sell-off at the outset of the 1997 Asian financial crisis. By the end of the crisis, a number of capital control measures were in place in Malaysia. Though most of these have been lifted, and the move to reintroduce RSS is an attempt to reinvigorate trading and interest in a market that was once one of the most active in Asia.
Yusli confirmed that foreign funds had accounted for over one third of the market's daily volume over the past few years, but added that there was a need for more trading that stemmed from investors' confidence and improved perception of the overall market.
Through RSS an investor can sell securities he has borrowed from a broker. The investor sells the borrowed stocks in hopes that the price will fall, and that he will be able to buy the same shares back at a lower price. The shares are then returned to the lender and the investor pockets the difference. Both parties can potentially benefit. The broker is able to enhance returns on their portfolios by lending some of their shares for a fee, while the investor is able to accrue profit from a declining market. Because they are paid fees either way, and want to keep customers happy, brokerage firms do not usually place a time limit for borrowing the shares of stock they loan.
Though in general the assumption is that the market will increase in value, the risks are theoretically the same for short-selling as in bullish long-term investing. The market can go down as predictably as it can go up. However the loss potential is much greater with short-selling. In conventional investment, the possible loss amounts are fixed and potential gains unlimited - a stock can add value infinitely but one can only lose the amount of his original investment. The opposite is true of short-selling, where the possible gains are finite.
In March, the government announced that it would reintroduce RSS in September, involving 100 stocks. In the event, short-selling in Malaysia will begin this month with between 40 and 50 stocks, selected according to their market capitalisation and liquidity. Besides the stocks themselves, Bursa will also monitor the quality of stock lenders.
But Yusli told reporters that the measured approach to short-selling is appropriate for Malaysia. "Let's remember that we are trying to bring back a facility which has been absent from this market for many years and we want to do it correctly," he said.
The exchange will adopt the central lending agency (CLA) model for its securities borrowing and lending (SBL). According to this arrangement, the bourse will act as a conduit, borrowing shares from lenders, which it will then lend to borrowers. A primary broker in other markets normally plays this role, though the CLA model is used in Singapore, Taiwan and South Korea. Bursa Malaysia has also indicated that it will only lend to locally licensed stockbrokers.
The exchange will limit the amount available for borrowing as a safety margin. According to some insiders, in a quiet market like Malaysia, short-sellers could have problems buying back shares quickly in the event of a sudden call back by the lender.
The bourse will also charge the stockbroking house an annual borrowing fee of 2.2% and will pay the lender of the equity 2%. Bursa would also require short-sellers' cash collateral be sufficient to cover 105% of their short-selling position - slightly more than in other markets. Borrowers can also use shares as collateral at 30 per cent of market value.
There have been questions concerning the effect that such a measured approach to RSS will have on trading. "The initial, still-changing plans for the reintroduction of regulated short-selling appear so cumbersome that many traders might give it a miss," CLSA risk and trading strategist Chris Lobello told a news agency.
While it is true that higher costs and a more regulated environment could turn off investors, Bursa Malaysia seems to realise that the work must continue beyond the day RSS is reintroduced.
According Bursa Malaysia's chief operation officer Omar Merican, the exchange has no illusions that seasoned offshore funds will immediately jump into the fray. "We are not looking for a big bang," he told reporters on Friday. "It's not going to be an overnight success."
However he also indicated that the careful processes that the exchange had adopted would be loosened and improved once short-selling was satisfactorily reapplied and confidence in the facility restored.
In spite of regulations and an intentionally measured development, RSS should increase the appeal of the exchange. It allows for more sophisticated investment strategies, a way to hedge risk, and activity even in a bearish market. All should increase the appeal of the exchange, and bring it closer to the ranks of mature, sophisticated markets. The primary question will be the extent to which the measures will foster more trading.
In the long run, RSS could also improve market fundamentals. Bursa will be better able to monitor how the market is developing and ensure that activities are conducted in a managed and transparent way. RSS will also help provide more accurate market valuation, as the facility tends to reward good fundamentals and punish bad valuation, leading the latter to be clearer and more transparent.