Historical background
A pilot scheme for regulated short selling was first introduced into Hong Kong in January 1994 with 17 securities being designated as suitable for short selling. Meanwhile, the ‘tick rule’ was introduced which prohibited the making of short below the best current ask price. The number of securities eligible for short selling increased in March 1996, and the tick-rule was abolished. Following the Asian financial crisis of 1998, the tick rule was reinstated and a tougher stance was taken against short selling misconduct.
Regulatory framework
Part VII of the Securities and Futures Ordinance (SFO) (Cap 571), deals with short selling restrictions. A short selling order is defined in the SFO, Sch 1, Pt 1 as an order to sell securities in respect of which the seller, or the person for whose benefit or on whose behalf the order is made, has a presently exercisable and unconditional right to vest the securities in the purchaser of them by virtue of having:
- under a securities borrowing and lending agreement-
- borrowed the securities; or
- obtained a confirmation from the counterparty to the agreement that the counterparty has the securities available to lend to him;
- a title to other securities which are convertible into or exchangeable for the securities to which the order relates;
- an option to acquire the securities to which the order relates;
- rights or warrants to subscribe for and to receive the securities to which the order relates; or
- entered into with any other person an agreement or arrangement of a description prescribed by rules made under the Ordinance.
Reference: SFO, Sch 1, Pt 1
Short selling is not taken to include an order where the seller, or the person for whose benefit or on whose behalf the order is made, has, at the time of placing the order, issued unconditional instructions to obtain the securities to which the order relates.
SFO, s 170(1) sets out the basic requirements. An investor looking to take part in short selling is required to have an exercisable and unconditional right to vest the securities in the purchaser of them. A breach of this provision is an offence and the investor is liable upon conviction to a fine of HK$100,000 and imprisonment of two years. However, under SFO s 170(3)(a), this does not apply to a person who, in good faith, believes or has reasonable grounds to believe that he has a right, title or interest to or in the securities borrowed for short selling.
Under SFO, s 170(2)(a), a person is regarded as ‘selling securities’ if he:
- purports to sell the securities;
- offers to sell the securities;
- holds himself out as being entitled to sell the securities; or
- instructs any representative of an intermediary that carries on Type 1 regulated activity for the intermediary, to sell the securities.
The SFO requires the confirmation of a short selling order. Where selling as a principal, a short selling order cannot be conveyed by a person through the Stock Exchange of Hong Kong Limited (SEHK) unless he provides documented assurance to his agent that:
- he has a presently exercisable and unconditional right to vest the securities to which the order relates in the purchaser of them; and
- where there is a short selling order, the counterparty or the other person (as the case may be) referred to in such paragraph has the securities to which the order relates available to lend or deliver to him.
Reference: SFO, s 171(1)
When selling as an agent, a person cannot receive a short sell order unless he has received from the principal, or the investor for whose benefit or on whose behalf the order is made, the same assurances.
Reference: SFO, s 171(5)
A person who conveys or accepts an order on behalf of clients or beneficiaries shall be regarded as a principal if he has full discretion to sell the securities to which the order relates and his conveyance or acceptance is not in accordance with any instruction from his clients or beneficiaries.
Reference: SFO, s 171(7)
An agent or exchange participant who receives or collects such an assurance must keep the documentation for at least a year and give access to the document upon request from the SFC.
Reference: SFO, s 171(8)
There is a requirement to disclose short sales under the SFO, s 172. An exchange participant or exchange participant’s representative who knows or is informed that an order to sell securities is a short selling order shall:
- when passing the order to any other person with a view that the other person shall input the order into the trading system of a recognized stock market, inform that other person that the order is a short selling order; and
- when inputting the order into the trading system of a recognized stock market, indicate such matters as may be required, under the rules of the recognized exchange company by which the recognized stock market is operated, to show that the order is a short selling order
References: SFO, s 172(1)A contravention of the above is an offence and individuals are liable to a Level 5 fine and imprisonment of one year. The exception is where the above is breached as a result of inadvertence, carelessness or negligence.
References:
SFO, s 172(2)
SFO, s 172(3)
An exchange participant’s representative means a licensed representative accredited to a licensed corporation that is an exchange participant of a recognized exchange company which operates a recognized stock market.
Reference: SFO, s 172(4)
SEHK Trading Rules
Only securities specified by SEHK as ‘Designated Securities Eligible For Short Selling’ can be sold short. A current list is available on the website of Hong Kong Exchanges and Clearing Limited. Until 15 March 2017, not all designated securities specified by the SEHK were reportable to the SFC, with the securities regulator providing a separate list of those which are subject to reporting. With effect from 15 March 2017, short positions in all designated securities are required to be reported and the list of designated securities can be found on SEHK’s website. Traders must abide by the SEHK Trading Rules with respect to short selling. The Eleventh Schedule to the Trading Rules sets out the short selling regulations other than the following list below, which are covered in the Fifthteenth Schedule of the Trading Rules:
- Securities Market Maker Short Selling
- Structured Product Liquidity Provider Short Selling
- Designated Index Arbitrage Short Selling
- Stock Futures Hedging Short Selling
- Structured Product Hedging Short Selling
- Options Hedging Short Selling
References:
Short Position Reporting – Frequently Asked Questions, 7 November 2017
Short Position Reporting Specified Shares, 15 March 2017
Short Selling Regulations, Sch 11
Designated Index Arbitrage Short Selling, Stock Futures Hedging Short Selling, Structured Product Hedging Short Selling, and Options Hedging Short Selling Regulations, Sch 15
The short selling regulations in the Eleventh schedule state that any short selling transaction must be concluded in a Designated Security which is executed through the SEHK’s Automatic Order Matching and Execution System (AMS/3).
References:
HKEX, List of designated securities eligible for short selling (14 October 2016)
SEHK Trading Rules, Sch 11, para 3
In addition, short sales cannot be made below the current ask price except where they are related to designated index arbitrage or made by market makers in their activities or hedging risks of their market making positions.
References: SEHK Trading Rules, Sch 11, para 15
Reporting short positions
Since June 2012, any person with a reportable short position is required to notify the SFC, as set out in the Securities and Futures (Short Position Reporting) Rules (Cap 571AJ).
References: Securities and Futures (Short Position Reporting) Rules
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