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5.15 pm
When I looked at the new clause a bit more carefully, I noticed that proposed new subsection (1)(a) bans short selling except under certain conditions-for example, in a rising market. That is a curious one-way ticket, and such an approach can only be distortive in any market-if one bans something in one direction and not in another, one will do a lot of damage to the process of trying to find a true price.
Proposed new subsection (1)(b) is even more bizarre, because it says that the only circumstances in which short selling are permitted are where
"the beneficial owners of the shares had given prior permission at an annual general meeting for the shares to be lent."
That is such a restrictive condition that it would suck all liquidity out of the forward markets, which would be the end of forward markets. Forward markets have been around a good while. There was an effective forward market in rice in ancient Japan, and it is said that there was one in China, so they have been with us for as long as there have been markets.
When examining the clause, one must ask a more basic question: do we want derivatives markets or not? If we decide that we need them, it is logical to try to maximise their liquidity, as that will lead to higher levels of capital formation and more efficient risk allocation, to the benefit of us all. Short selling strengthens the long market; it provides strategic investors with an opportunity to hedge their positions and gives them confidence to take those long positions. An investor will be much more reluctant to buy if the would-be short sellers' views are not expressed in the market and are distorted by restrictions.
The key question is always that of investor confidence. I took a look at a number of things on the web about what various people have had to say on this matter recently. Troy Paredes, a commissioner on the Securities and Exchange Commission, recently gave an interesting lecture to the Harvard law school forum on corporate governance in which he came to a pretty clear view. In line with what I have just implied, he said:
"Short selling...is tied to investor confidence. Investor confidence depends on investors' faith in the integrity of markets. Investors expect that securities prices are meaningful in that they reflect the market's overall assessment of what a company is 'worth' by aggregating into a single number the different views of market participants...in promoting market efficiency, short selling can foster investor confidence, as investors can be confident that securities prices reflect both optimistic and contrarian views."
I could not have put it better-in fact, I could not have put it remotely as well. That is a clear expression of the need to retain short selling.
The risks usually attributed to short selling-the right hon. Member for Birkenhead followed that approach-generally turn out to be something else. They turn out either to be the risk of share price
manipulation, which he did not discuss very much, or to be fraud, which he discussed quite a bit, which is why I intervened on him to clarify what was going on in the Maxwell custodial case. Those are, quite rightly, already offences under existing law, and if the law needs tightening in that field-the right hon. Gentleman has suggested that it does-we should pay particular regard to that. We should look carefully to see what further steps should be taken to make share price manipulation and fraud more difficult.
As this clause is about short selling, we are concentrating on practices that take place with respect to shorting the market. The long share market, however, is just as vulnerable to fraud and manipulation. One such practice, which good quality regulation seems substantially to have reduced, at least, was known as "ramping the stock"-talking it up while taking a holding and then selling up, leaving the poor souls who had taken the advice to take the fall in the market afterwards.
Stewart Hosie (Dundee, East) (SNP): The hon. Gentleman has talked about shorting the market, which is one of those expressions that everybody thinks that they know the meaning of. Is not the fundamental problem with this new clause the fact that it would outlaw any selling when the price is falling, assuming that that is short selling?
Mr. Tyrie: I think that that is more or less correct. I am not absolutely sure what the effects of the new clause would be, to be frank-I am not absolutely sure that its authors are sure what its effects would be-but I am pretty confident that they would be disastrous. Even as a probing new clause, I do not think that it is near the target that the right hon. Member for Birkenhead mentioned as justification for it.
There is a second, more general justification for the introduction of measures to restrict short selling, which is that it can encourage panics and irrational behaviour. Of course, as I have pointed out, that is just as true in a long market. Is that not what we have always seen in the long markets? These are the booms before the busts-the Mississippi scheme in France in the early 18th century, the South sea bubble, the bubble in share stocks in the interwar years and the bubbles that we have had more recently. To stop the bust, one must find a way of stopping the boom. Stopping the boom is an extremely difficult task, too. In other words, creating market stability is, in my view, probably a very difficult, if not impossible, task that Governments should address with very great care. After all, was it not this Prime Minister who told us about 160 times in this place alone that he had put an end to boom and bust? He gave us the most spectacular boom followed by the most spectacular bust in living memory-at least, apart from in the memory of those who are old enough to remember the late 1920s and early 1930s.
The problem with booms and busts is that they are monetary phenomena. They are normally driven partly by loose monetary conditions, in one way or another. Although this more general issue goes well beyond the remit of the new clause, it is worth pointing out that the Government are trying to do something about it through counter-cyclical capital requirements, for example, and a number of other measures. They are considering the development of macro-prudential tools that are designed
to attenuate the virulence of the cycle. That is a very difficult task, however, and they are realising just how difficult it is as they take their ideas forward, not least because the law of unintended consequences usually applies.
There is legislation to bear down on disorderly markets, but of course that is not a ban on short selling, but a ban on all selling and buying. The most common measure-although, again, it has been rarely used-is to close a market temporarily, when it is felt that a meaningful price cannot be established. One of the problems is that it is increasingly difficult to achieve that in a globalised world in which grey markets operate.
There is one last argument for action on short selling for which I have a good deal of conceptual sympathy, but I am afraid that the new clause goes way beyond what is required. In any case, I think that the necessary legislation for emergency action is already on the statute book. I am talking about circumstances in which a disorderly market can trigger a sharp increase in systemic risk and risk a breakdown of the whole economic system. I think that the recent temporary ban on short selling was imposed to prevent that from happening. It was based on the argument that the protection of the wider public good is an objective that overrides all others for a period of time, but was it of any use? With the benefit of hindsight, can we say that we got anything back in return?
The chairman of the Federal Reserve has already said on the record that he would not impose the temporary ban again. The FSA and the Government have been much more circumspect about saying that it did not work, and I shall be interested to hear what the Minister has to say about that in a moment. However, the prevailing view among a good number of insiders-I know a few of them-is that more harm than good was probably done.
In that respect, it is worth looking again at what was said in the lecture to which I referred a moment ago. Troy Paredes covered his back a little, but he is one of the world's leading experts on this subject and, before new clause 8 is considered seriously for the statute book, we need to consider what such people are saying. He said:
"With the benefit of more but still imperfect information, the decision was made to terminate the ban a few weeks after its implementation. Speaking personally"-
this is him covering his back-
"it became apparent that the ban did not stabilize the markets but did result in inefficiencies and other market dislocations and disruptions. In short, the benefits of the ban did not materialize but the costs clearly did."
I have not looked in great depth at the specific issue that Dr. Paredes addressed, but it would not surprise me if, having done the cost-benefit analysis for ourselves, we were to reach a very similar conclusion.
The SEC has retained rules that penalise so-called "naked" short selling-that is, when the short seller does not deliver the securities within a short period after the sale transaction date. However, it is worth reminding ourselves that most forward positions in the spot market are covered, and that they are not so-called "naked" short or long positions.
The plain fact is that we have all benefited enormously from the development of forward markets and financial innovation over the past quarter century. That is not a
popular view to articulate at the moment, because we have just suffered from a spectacular failure in the markets, part of which is attributable to the derivatives market. If new clause 8 were implemented, the inevitable consequence would be that we would lose the long-term liquidity and benefits that come with these markets. The idea that we could do without those things is not one that we should seriously entertain.
I very much hope that the Government do not support new clause 8, and that the Minister is courageous enough when he replies to explain the merits of short selling, as well as the disadvantages.
5.30 pm
Mr. Breed: As the right hon. Member for Birkenhead (Mr. Field) suggested, we found ourselves in agreement on some of the sentiments. Some of what has gone on over recent years has highlighted a number of practices that may not have been well known or well understood, and he gave the example of the pension fund chairman. As the hon. Member for Chichester (Mr. Tyrie) said, short selling has been part of the functioning market for some time, and it is part of how investors have confidence in the market. The loaning of pension fund shares might be looked at under pension fund administration arrangements. The rules could clearly be tightened up. I suspect people would not necessarily demur from that within the totality of their involvement in the market.
We discussed the merits of the restrictions in clause 13, which would give the FSA powers to prohibit or require disclosure, very much along existing lines-formalising what the FSA did a little while ago. It addresses perceived market abuse, usually a one-off emergency situation and alongside a disclosure regime. It is probably about as far as we would wish to go at any particular time.
Throughout our consideration of the Bill, we have been concerned not to take it that market abuses and other problems were everyday events and that we had to produce reams of draconian legislation. We wanted to ensure that the rules were proportionate and would address certain situations that may arise in the future. The hon. Gentleman said that the alternative would be to close the market in certain things altogether, but if we were for ever doing that it would destroy the whole function of what we are trying to set up.
Although I can understand why the new clause was proposed, and there may be opportunities to reconsider it in another place, at the moment it is too restrictive for us. It could have many dire unintended consequences, so at this stage we cannot support it.
Mr. Hoban: When the right hon. Member for Birkenhead (Mr. Field) introduced new clause 8, I was intrigued by his arguments for its rationale. As he developed his argument from Maxwell and Sir John Cuckney to the role exercised by trustees in determining investment strategy and the use to which investments should be put, he made a strong case for improving the Government's arrangements for pension funds. However, if the purpose of his new clause was to prevent shares owned by pension funds from being used as a cover for short selling, he should perhaps have tabled a new clause in favour of naked short selling rather than one that restricted covered short selling to certain areas.
Mr. Frank Field: If the hon. Gentleman looks at the new clause, he will see that that is what I am advocating. Members should know that their shares are being sold in that way.
Mr. Hoban: But in a way there are two types of short selling. There is naked short selling, when someone does not hold the shares, or has no coverage for selling the shares in the market, and the situation when someone borrows shares and there is some cover to minimise settlement risk. The right hon. Gentleman's argument was about the governance of pension funds rather than the merits or otherwise of short-selling strategies in the market, and I thought it did not quite get to the point.
As a consequence of interest in short selling, quite a lot of work has been done on the possible impact of various short-selling strategies on the underlying markets, and on whether short selling itself is a legitimate strategy for investment managers. On a couple of occasions during Treasury questions, the Minister has defended short selling as a means of improving liquidity in the market, reducing transaction costs and making markets function more effectively. A number of pension funds benefit from the strategy because they have investments in hedge funds that engage in such activities. At the peak of trading in 2008, pension funds apparently earned about £600,000 a day from the fees that they received in return for lending their stock.
Mr. Field: May I give an example about the fees? The pension fund that I mentioned was paid £900 for every £1 million of its stock, which was being lent without its knowledge.
Mr. Hoban: No one is saying that the fees are especially generous, but the funds charge a fee for lending their stock, and that fee is of course used to augment the returns of the underlying pension fund. There is a need to think about the cost-benefit analysis.
Mr. Tyrie: Is not the key issue that that situation represents a failure in the corporate governance of the pension fund itself? The responsibility for that inadequate charge, given the risk involved in the transaction, lies squarely with the directors of the pension fund.
Mr. Hoban: My hon. Friend is absolutely right. The argument made by the right hon. Member for Birkenhead seemedto be more about how we improve the governance of pension funds than about the merits or otherwise of short selling. The fact that the trustees did not know what was happening suggests that more due diligence should have been carried out in respect of the nature of their agreement with their investment manager and the custodian.
Mr. Frank Field:
It is clear that a number of debates are going on. In the contribution made by a very distinguished apostle of short selling, we heard that, in all possible worlds, it is an extraordinary activity that benefits market liquidity and that it should therefore be ungoverned. In the specific case that I have cited, the chairman of the pension fund undertook inquiries before he heard about the introduction of my Bill to ban short selling. There was no failure there, although a general failure might have arisen because the House made such a fuss about the role of the custodian, who was the
person who put the lock on any use of assets without the knowledge of the pension fund. There is of course an issue surrounding corporate governance, as the hon. Member for Chichester (Mr. Tyrie) suggested, but the problem is wider than that. I approach this matter with the view that short selling-gambling with people's futures-is not necessarily a good activity, even if that activity is draped under the guise of liquidity.
Mr. Hoban: I am now a bit more confused about the right hon. Gentleman's position. Does he wish to improve the corporate governance of pension schemes by ensuring that there are proper arrangements among trustees, custodians and investment managers, or is he opposed to short selling as a matter of principle? His new clause would allow short selling in two cases: if there were improved governance arrangements and if
"the share price at the time of the transaction was higher than it was at the close of the previous trading day".
I am not entirely clear whether shares could be lent if the short selling was on an uptick even if the custodians had not been given permission. There is confusion even in new clause 8(1)(a) and (b). Would the custodian always need permission to lend, or would that permission be necessary only in certain circumstances? Perhaps the right hon. Gentleman will deal with that point in his winding-up speech.
Mr. Tyrie: For the sake of clarification, so that Conservative Members are clear on the matter, it has been implied that somehow we favour an unregulated free-for-all on short selling. I hope it is the position of Conservative Front Benchers-it is certainly mine-that short selling and, for that matter, the long derivatives markets need to operate within a framework of regulation, and that we are not in favour of a market in which share price manipulation and fraud such as we saw in the Maxwell case can flourish.
Mr. Hoban: Indeed. To be clear, that is why the right hon. Gentleman is misguided in tabling amendment 1, which would remove clause 13. That clause sets out a proper framework for the regulation of short selling and will replace the existing regime, which is based on the market abuse directive-many people thought that directive was inappropriate.
The clause will introduce a new framework, which will be part of the Financial Services and Markets Act 2000, to enable the Financial Services Authority to take action in certain cases. That is the right response-a proportionate response to the risk that has been identified. Indeed, when the FSA intervened in September or October to ban short selling for financial institutions, we were supportive.
All those activities need to take place within the proper regulatory framework, and in considering different aspects of short selling and the different approaches that one might take to tackle some of the issues around it, we need to think carefully about what is the right cost-benefit analysis. Is there a legitimate reason to allow short selling? If we were to restrict short selling, what would be the consequences? I have already made it clear that one such consequence would be a reduction in the relatively small amount of income that pension funds get from lending their shares.
In the aftermath of the temporary measures that the FSA introduced last year, it has produced a discussion document that considers short selling and thinks about the potential implications of the restrictions that could be introduced to make short selling more difficult. Interestingly, two of the measures that it suggests reflect measures proposed by the right hon. Gentleman. The first is a prohibition on naked short selling to ensure that it occurs only when cover is in place. Some proponents of a ban argued that it would reduce settlement failures and limit
"the speed and the extent to which a short selling strategy can be executed and thus...act as a brake on more aggressive short selling".
The other side of the argument-the argument made by those in the market-is that a ban on naked short selling
"would prevent legitimate behaviour which can provide beneficial market impacts."
For example, a ban on naked short selling
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