"would stop intraday naked short selling"
"significantly impair the ability of market makers to function properly, as it is often a necessary part of their role to short sell to meet client demand for a stock."
"Although a prohibition on naked short selling...would be less far-reaching than a prohibition on short selling generally",
"would still have net negative impacts."
The right hon. Gentleman has also introduced a form of the uptick rule, which has been used in the States: people can sell only in a rising market. That has been a feature of the US regime for some 70 years. Again, it was discussed in the context of regulatory reform here in the UK. Interestingly, the Securities and Exchange Commission concluded that it
"should remove price test restrictions because they modestly reduce liquidity and do not appear necessary to prevent manipulation".
It came in for a bit of flak for that-it was before the financial crisis-and some argued that if the SEC had still had its uptick rule, that would have reduced some of the turbulence in the financial markets in the wake of the credit crunch. Having said that, the evidence suggests that those rules provide limited protection against the negative effects of short selling, and the FSA commentary says that at most they act
"temporarily to decelerate share price declines."
It is right to discuss measures that could restrict short selling, but the debate under the auspices of the FSA would suggest that, on balance, the measures proposed by the right hon. Gentleman are detrimental to investors, rather than achieving a net benefit. The extensive work by the FSA would argue for a rejection of new clause 8, but if he is concerned about governance, there are other ways of doing it, and we should not try to restrict short selling through his proposals.
John Howell (Henley) (Con): This is the first debate initiated by the right hon. Member for Birkenhead (Mr. Field) in which I have participated. It has been an interesting discussion about what, I am sure, many people outside the Chamber regard as a rather esoteric but nevertheless important subject. If there are concerns about the role of the custodian, I am confused as to why the right hon. Gentleman did not table a new clause specifically to deal with that, because we might want to discuss a number of problems related to that and how that role fared throughout the recession.
The proposals would make a fundamental change to the measures set out in the Bill, as they would move from a situation in which short selling is allowed unless it is banned to one in which it is banned unless it is allowed. When my hon. Friend the Member for Chichester (Mr. Tyrie) and I were in central and eastern Europe, introducing market economy and democracy to those areas back in the '90s, the distinction between a society in which something was allowed unless banned and one in which something was banned unless allowed was the principal distinction that underpinned the difference between the free markets of the west and the markets that we were trying to eradicate under the old communist system. When we used the word "eradicate", we meant "eradicate", not "reduce it to 10 per cent."
When the Committee discussed the issue, there was a question about the basis on which we were working. There was considerable consensus that regulatory intervention was justified where there were identified market failures, and it was expected to deliver net benefits to the market. That was certainly the presumption in our significant debate about what those market failures might be. The obvious example of abuse was largely covered by the FSA's existing powers, but there was also the question of the disorderly markets that we have seen in the current crisis, as well as deficiencies in transparency.
"Short selling can generally be expected to increase market efficiency but can have negative impacts. In times of extreme market turbulence and for firms engaged in rights issues these risks are heightened. The fact that short positions are not normally disclosed to the market may also result in market transparency failure. Nevertheless, given that short selling has clear benefits, restrictions on it do appear to come at a cost".
"It is not clear whether a lack of transparency about the level of short selling and the identity of short sellers gives rise to a material market failure."
My hon. Friend the Member for Fareham (Mr. Hoban) touched on some of the options that the FSA identified. There are six in all. One of them, which follows the right hon. Gentleman's line, was to prohibit the short selling of all stocks. Other options were to prohibit naked short selling, prohibit short selling of financial sector stocks, prohibit short selling of companies engaged in rights issues, prohibit short selling by underwriters of
rights issues, and finally, prohibit short selling where there is urgent need. It is the last one that we have ended up with in the Bill, although it is the first one towards which the right hon. Gentleman's new clause is edging.
As stated, there were a number of costs in terms of pricing efficiency, liquidity and forgone profits. One of the issues that needs to be explored further-I have no idea whether the right hon. Gentleman has thought through the implications-is the costs of the scheme. It concerned me in Committee that with the Government's preferred option, they were rather clutching at straws, given the wide ranges put forward in the impact assessment, which went from £106 million to £1,066 million as the cost of the option that they eventually chose, which is now in the Bill. It would be interesting to see whether there was a quantification, how much wider that might be and what the top end of it might be, if one followed the right hon. Gentleman's view.
The other issue which it is important to mention is the relationship with the international regime, which has not been touched on so far. There is an admission already by the Treasury that the UK currently has a wider definition of market abuse than many of our European counterparts. Even the FSA admits that market participants have encountered problems and significant costs in having to comply with the variety of different regimes introduced across a number of different jurisdictions. It should be recognised that we need to be seen to have a regime that is applied as widely as possible internationally. We struggled with the clause currently in the Bill, and how that fitted in with the international regime. One of the witnesses who spoke to us concluded- damning with faint praise-that it would probably work out all right because the wording is sufficiently wide that in all probability it will allow anything into it, which is hardly a glowing endorsement.
I find it difficult to see how the new clause would fit in with the approach adopted by other countries. Germany has a ban on naked short selling, but only on specific financial institutions, not generally. In its approach, France has aimed at the short selling of financial sector securities as well. Finland has opted for considering more supervision, rather than any banning. The Czech Republic, being the Czech Republic, has opted for no action whatever on the matter.
The only country that I could find, although there may be others, where there was any semblance of a relationship to what the right hon. Gentleman was hinting at was Belgium, where the whole approach to short selling was linked to good order, integrity and transparency. The rules there were to ensure that sales were covered, but with restrictions on the lending of shares. It is not a regime that has widespread attraction or merit. If we adopted the right hon. Gentleman's new clause, therefore, we would end up down an alley of regulation where none of our European competitors would want to go. That would leave the UK exposed.
Amendment 1 would delete proposed new part 8A of the Financial Services and Markets Act 2000, which aims to provide the FSA with a new power to prohibit,
or require disclosure of, short selling. New clause 8 proposes an alternative prohibition. I listened carefully to the arguments put forward by my right hon. Friend the Member for Birkenhead (Mr. Field) who expressed general concerns about short selling, which I believe are shared by people who consider it to be a dangerous and speculative type of financial transaction. He referred to it as gambling, but I cannot agree with him.
It is indisputable that, in certain circumstance, short selling can have adverse impacts, which can endanger financial stability. That is why the Government are committed to ensuring that the FSA has powers to intervene to prevent short selling and require its disclosure where necessary. But it is my view and that of the Government that, in general, short selling has clear beneficial effects for the market.
Short selling is an important source of liquidity, it is a common risk management tool, and it improves pricing efficiency. That is why I believe the targeted approach and the proportionate way we are tackling the issue through clause 13 will allow the benefits of short selling to be claimed by those who use it responsibly, while preventing those who would seek to abuse it from doing so. That is preferable to the blanket prohibitions proposed.
The hon. Member for Chichester (Mr. Tyrie) sought evidence of the efficacy of the recent ban on short selling. As he is aware, the ban was aimed at preventing the short selling of UK financial stocks, other than in permitted circumstances. The FSA monitored compliance with the ban and considers that it achieved its aim. In the future there will be academic studies examining short selling bans in great detail, but in those narrow terms the measures that the FSA introduced were effective in achieving its aims.
As my right hon. Friend the Member for Birkenhead knows, his new clause would prohibit the majority of short selling in shares. First, naked short selling-that is, where the seller sells shares that he does not own, without having borrowed or otherwise set aside any shares to settle the transaction-would be permitted only if the share price at the time of the transaction was higher than the closing price the previous day. Such a prohibition, as we have heard, is known as an up-tick rule, and would allow unrestricted short selling in an advancing market, but would prevent short selling at successively lower prices. There is little evidence that this method does anything other than decelerate a share price decline.
As we heard, the FSA looked at the introduction of an up-tick rule during its 2009 consultation and concluded that the costs that firms would incur to implement such a rule far outweighed the benefits. Respondents to the FSA consultation strongly opposed the introduction of an up-tick rule.
The second prohibition proposed by the new clause would restrict covered short selling, where the short seller has borrowed shares, to circumstances in which the beneficial owners of the shares had given their permission at an AGM for the shares to be lent. I understand the purpose behind my right hon. Friend's proposal, but this may increase the costs of covered short selling by limiting the extent to which some entities are able to lend their stock and depriving them of low-risk income in the form of lending fees. However, in the Government's view, it would not act as an effective control over short selling.
The prohibitions proposed by my right hon. Friend would be blunt and inflexible. I appreciate the probing nature of the new clause, and it is important that we have this debate. As they stand, however, the prohibitions would not allow the FSA to impose targeted controls on short selling, by banning short selling in particular financial instruments, or instruments issued by a particular company on a temporary basis. As a result, we consider that they would not adequately assist the FSA in protecting the stability of, and maintaining confidence in, the financial system.
The new clause would require disclosure to the FSA of all short selling, regardless of how small the transaction is. The FSA would be given no discretion to adjust the contents of the declaration, to ensure that the obligations imposed under this provision were proportionate. The Government's view is that there is no evidence to suggest that requiring such extensive disclosure would produce any benefits to outweigh the extensive costs it would impose on companies.
There is, as I am sure the House is aware, a global regulatory consensus that requiring disclosure of short positions will help to reduce the potential for abusive behaviour and disorderly markets, and I am sure we all agree with that. A great deal of work is taking place to try to secure international agreement on how that can be effectively implemented consistently. We are certainly working hard to ensure a pan-European approach to short selling, and the disclosure regime that is likely to be agreed in Europe is intended to include the disclosure of significant net short positions; a two-tier disclosure model, with private and public disclosure set at different thresholds; the incremental disclosure of changes of position above both thresholds; and an exemption for market makers. It is intended also to apply to positions in all shares, not just shares of financial stocks. I can therefore assure my right hon. Friend that a great deal of work is going on in that regard.
My right hon. Friend also raised the issue that other hon. Members suggested was primarily one of corporate governance. His point was whether trustees of pension funds or, by analogy, directors of companies knew that their stock was being lent. The Financial Services Secretary, Lord Myners, has commissioned an informal review of stock lending, and any further safeguards that might need to be recommended to stock lenders, including pension funds, would be considered as part of that. My right hon. Friend highlighted the point, but other hon. Members responded by saying that boards and trustees are responsible for ensuring that they have corporate governance procedures in place adequately to control the funds and companies with which they deal. I am sure that that is absolutely correct, but in these circumstances the Government and the FSA may wish to issue advice on stock lending, and that is being looked at.
Mr. Frank Field:
I have learned much from this debate, not least from the disclosure by the hon. Member for Henley (John Howell): I had no idea that he and the hon. Member for Chichester (Mr. Tyrie) were outriders for the free market in eastern Europe. Although that
free market may have been beneficial overall, there have in those societies been many permanent losers from the new gospel that they have taken to those countries.
What disturbs me most about the debate is that I have failed to register in all parts of the House that there was-anyway, but even more so after the banking and economic crisis in this country-disquiet about the fact that people can use shares that are not theirs to force down the price of those stocks and perhaps endanger a company's future; that they can undertake similar activities with the basic things that we need for our everyday lives, such as oil and food; and that somehow those activities will continue. However, my hon. Friend the Minister is right: my proposed change is a probing new clause, and we will have a chance to consider what has been said today before the measure appears in another place.
Before I withdraw the new clause, may I state on the record that, until the debate opened, I did not know that my hon. Friend was not standing at the next election? I am sure that it is good news for him-otherwise he would not have made the decision-but it is bad news for the House.