New short-selling proposals from the Japanese Financial Services Agency (JFSA) will improve liquidity by encouraging greater market making activity, but could pose challenges for brokers that have to modify algos and risk management systems.
Last week the JFSA launched a comment period for its latest short-selling proposals, which seeks to move the uptick rule – which only allows short sales if the price of a security is at least a tick higher than the previous trade – to a circuit breaker-based model. Under the proposals, the uptick rule will only come into force if a stock moves 10% lower than the previous day’s closing price. Once this threshold is breached, short selling in an affected stock will be prohibited for the rest of the trading day and the following trading day.
According to Chuck Chon, co-CEO of SBI Japannext, a proprietary trading system that accounts for around 4% market share of Japanese stocks, the relaxation of the uptick rule is a major step in the right direction that will promote more active trading across all trading venues in Japan.
“We applaud the JFSA’s plan for the relaxation of the uptick rule,” Chon told theTRADEnews.com. “It will be particularly good for market makers that use covered short sales to manage risk and will therefore find it easier to manage the risk associated with providing liquidity.”
The potential easing of the short-selling rules will also allow the buy-side to deploy a wider range of strategies in Japan.
“The relaxation of the uptick rule will remove one of the major frictions in the Japanese market. Clients will be able to launch new strategies they may have been reluctant to pursue and increase trading through existing strategies that may have been encumbered by this rule,” said Ross Whittaker, head of Advanced Execution Services, Japan, Credit Suisse. “It will also allow Japan to more closely resemble western and other Asian markets. This standardisation will allow clients and brokers to easily port their trading methodologies and technology to Japan.”
However, one issue arising from the proposal is the need to exclude short selling in the stocks that breach the 10% for the next trading day.
“We strongly believe that the new uptick rule if carried over to the next trading day, albeit synced with primary exchange’s circuit breaker stock names, will trigger difficulties with the majority of broking members who have to modify their algo engines, risk management systems, etc,” added Chon. “We are in favour of an intraday only implementation and a reset for the next trading day.”
Whittaker said Credit Suisse already has a mechanism to deal with stocks affected by the uptick rule, but said the technology would have to refined so that it is more nimble to ensure it can identify when stocks would be subject to the 10% rule.
Chon added that SBI Japannext was also in discussions with the JFSA regarding how the short selling rules would apply to its night-time market, given it was the only market to offer after-hours equity trading.
In addition to the modified uptick rule, the JFSA has also proposed a permanent ban on naked short selling, whereby securities are sold short without a borrowing arrangement, and new tiers for when short sale positions should be reported and announced publicly.
The JFSA will receive comments on the proposed rules until 8 April, with a view to implementing the new legislation until November 2013.