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Australia: Short-selling bans 'causing chaos'

Britain was the first to ban investors from taking short positions on banking and financial institutions' shares last week and was followed on Friday by bans in the US sharemarkets.

The Australian stock exchange (ASX) took it one step further on Monday banning short selling across the entire market. Its introduction saw a one hour delay of the market opening as clarification was sought over who would be affected. ASIC contends that it couldn't stand alone once the US and Britain banned shorting of financial stocks, and were followed by other countries, and that's undoubtedly the case. It may, however, have been overkill to widen the ban from financial stocks to all listed stocks.

The bans have been introduced to stop investors from shorting shares and driving share prices to the point of collapse. The finger has been pointed in particular at some US hedge fund managers who are said to have purposely driven down the price of shares using "naked" shorting in companies like the now bankrupt Lehman Brothers in order to make a profit.

Britain had been clear about including CFDs in its ban but other countries had not made it so simple. A commission spokeswoman said the prohibition did not apply to CFDs in Australia, because they were derivatives. But without the ability to take short positions on the market as a hedge, most CFD providers had little choice but to stop offering "short" CFDs.

The British ban extends until the end of the year while in the US it lasts until October 10. Australia had put its ban in place for one month.

As the Australian regulator has now discovered, its haste has caused further complications. Shorting takes many forms, notably among derivatives, in which shorting can take place via contracts for difference, equity swaps and put options. Moreover, banning shorting can prevent traders from hedging their risk via physical equities.

As a result ASIC has been forced to grant a number of exemptions to the shorting ban. Yesterday, the regulator clarified that market participants were still able to conduct both buy and sell transactions in all ASX exchange-traded options and market makers could hedge those options transactions through covered short selling in the physical market. ASIC also said it would exempt short selling as part of arbitrage transactions involving dual-listed entities, such as BHP Billiton and Rio Tinto.

That all suggests the correct approach is not to outlaw short selling but to ensure transparency by requiring greater disclosure. Shorting is a very risky exercise, as there is no limit to the downside. The stampede effect that short sellers have been able to achieve in stocks such as Allco Finance, Babcock & Brown and Macquarie is only possible when market participants must guess at what is happening.

South Africa: Trouble at Dealstream

Dealstream is one of South Africa’s largest Contracts For Differences ("CFD") traders and, in this capacity, it has concluded many over-the-counter ("OTC") CFD’s with its clients.

Clients of Dealstream are concerned after the company's trading system went down last week. Calls placed to the derivatives broker and its CEO Russell Leigh went unanswered Monday morning. A visit to Dealstream's offices in Melrose Arch confirmed there was no one there.

The company is run by Russell Leigh, a regular market commentator for many of the financial publications. The company includes Argil Venture Capital (Argil) as an investor. Argil is a fund manager owned by auditing firm Ernst & Young Southern Africa and Worldwide African Investment Holdings. Argil's first fund is an innovation and technology fund, which was launched with R100m in investment capital.

"As the contracts signed were over-the-counter contracts between Dealstream and its clients that are neither concluded on the JSE nor regulated by the JSE in terms of its rules, neither Rand Merchant Bank nor the JSE will be liable for Dealstream's failure to meet its commitments to its clients," Allan Thomson, the JSE's head of derivatives trading, said in a statement.

"What is disconcerting is the lack of information from the company," said one investor who contacted Miningmx.

According to one investor, warning flags were raised last week: "Last Wednesday afternoon the system was online but trades were not going through. Dealstream said it would enter them for us but one could not see if trades went through or not. Thursday was the same. By Friday afternoon, the system went offline 'due to technical difficulties' and this morning the site remained offline."

Rand Merchant Bank (RMB), a division of FirstRand Bank Ltd, is the clearing member for the SAFEX activities of Dealstream Securities (Pty) Ltd. In terms of this relationship, Dealstream is required to post margins with RMB in respect of their open trades.

In terms of the JSE Derivative Rules, RMB has placed Dealstream in default as they are unable to fully reinstate their minimum margin requirements. Dealstream's transactions on the JSE were for their own account. Dealstream does not have any clients registered on the JSE and did not conclude transactions on the JSE on behalf of clients. As a result of this, Dealstream's clients do not have any recourse to RMB in respect of their transactions with Dealstream.

Clients familiar to the situations are claiming that money that was deposited into Investec trust accounts was used by Dealstream improperly. Dealstream had power of attorney over trust money. This money was meant to be used to fund clients' losses when trades moved against them. However, clients say that money was removed from the trust accounts by Dealstream even when there was no need to access it. This means that clients stand to lose millions. Reed estimates that he and fellow employees have together lost about R112m in their personal capacities.

What the money was used for remains uncertain. However, it has been speculated that it was being used to fund positions held by Dealstream in Vox Telecom and Simmers & Jack Mines (JSE:SIM). Investec head of investor relations Ursula Nobrega said she could not confirm the balances were zero. She cited client confidentiality. Since 8 September 2008, Simmers & Jack Mines has lost 33% of its market value, falling from a high of 399c to 260c. The share price has subsequently rebounded 5.6% or 15c during trade on Monday on the back of stronger equity markets. Over the same period, the Vox Telecom share price has moved significantly. Since the 8th, the share price has moved from a low of 198c to hit a high of 225c. On Thursday last week the share traded down around 5% (10c) and lost another 9% (20c) on Monday to trade at 200c.

Nobrega said at all times Investec was acting on behalf of Dealstream. She says Dealstream clients were not clients of Investec. Reed recounts how he met with Dealstream CEO Russell Leigh on Sunday after he heard rumours of troubles at the derivatives broker.

"We actually believed him," said Reed. "He convinced us that everything was absolutely safe." Leigh apparently showed Reed printouts of trust accounts, reflecting that his money was safe. However, when news of Dealstream's problems broke on Monday morning, Reed realised he had been fed false information.

He says he managed to confirm that most of the trust accounts held by Dealstream with Investec had zero balances. Leigh appears to have gone to ground. He is not answering his cellphone. Saul Cohen, a spokesperson for Argil, a shareholder in Dealstream, says its offices were vacated after a client threatened employees with violence.

Alpino says he contacted Investec last week, who confirmed that certain trust account balances were zero. Dealstream's clearing house RMB has assumed responsibility for its open trades on the JSE. This happened after Dealstream failed to meet its obligations to RMB.

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