US equities trading platform Direct Edge has criticised calls for a “modified uptick rule” to prevent abusive short-selling of US equities, arguing that such restrictions could limit liquidity and create greater selling pressure in a falling market.
In March, the US’s three biggest exchanges – NYSE Euronext, Nasdaq OMX and BATS Exchange – wrote to Mary Schapiro, the new chairman of the US Securities and Exchange Commission, proposing the introduction of a revised version of the uptick rule that was repealed in 2007.
The original rule only permitted short-selling when the
last sale was at or above the value of the previous sale. The three exchanges suggested a new rule which only permits a short sale at “a higher price that the prevailing market at the time of initiation, and only on a passive basis.” They also recommended the new rule be used in conjunction with a circuit-breaker that would kick in if a stock dropped sharply.
These proposals prompted Direct Edge to respond with its own letter to Schapiro. “Direct Edge does not believe that a so-described ‘modified uptick rule’ is the proper form of short sale regulation because it would act as a broad-based restriction on the liquidity trading strategies of market participants and the liquidity traded thereby,” wrote Direct Edge’s general counsel,
Eric Hess, in the letter.
Hess further asserted that taking the approach suggested by the exchanges would exacerbate stock price falls. “The existence of short-sale circuit-breakers, or any trigger based on a market condition for that matter, could artificially increase selling pressure on stocks as their value approached the relevant price level, as sellers would have an incentive to engage in premature selling in anticipation of the restriction becoming active,” he wrote.
Direct Edge argues that a better approach to tackling abusive short-selling would be to enhance transparency and tighten enforcement against so-called naked short selling – selling a stock without first borrowing it – and fraudulent conduct. “Targeting identified conduct would enhanced the benefits of the regulation and reduce costs, both in terms of implementation and market impact,” Hess wrote.
There has been widespread regulatory concern about the effects of short-selling on stock prices after share values tumbled in the second half of last year. Many regulators placed restrictions and outright bans on short-selling following the falls.