The Japanese Financial Services Agency (FSA) has introduced new rules for short selling, effective as of today. The revised short selling rules apply to all cash products, including stocks, convertible bonds, ETFs, and REITS.
The change is being carried out at this time because Japan is moving to adopt proven practices of other markets and exchanges, in order to keep it competitive and to potentially increase trading volumes. The revised rules should improve liquidity and price formation and simplify the trading workflow.
The changes to short selling in Japan fall into two categories. Firstly, the FSA had previously implemented temporary measures (for example, a ban on naked short selling) during the 2008 financial crisis and these will now be made permanent.
Secondly, the FSA has modified the long-standing uptick rule, which prohibited short sales unless the order's limit price was higher than the last price, (meaning the price for the most recent execution on an exchange).
Currently, the uptick rule applies to all short sale orders made on financial exchanges in Japan. This rule is a test that every short sale order has had to pass in order to be accepted by the exchange.
However, with these changes the uptick rule will only take effect after a trigger price is reached. Until this is triggered, firms can short sell regardless of whether the instrument's price is moving up or down.
The revised short sale regulations will ease the uptick rule to only apply to cash products which have declined in price by 10% or more from the previous day. This is referred to as the ‘trigger price’. Furthermore, the uptick rule will only apply to triggered cash products. The uptick rule will no longer be in place unless this trigger is met.
A product is triggered upon a price decline of 10% or more from the previous day’s closing price on the primary exchange (rounded down to the nearest tick), and the product remains triggered through to the end of the following trading day.
“From a trader’s perspective, the new rule may be viewed as positive as it offers more flexibility for short selling,” said Chris Jenkins, Asia Pacific managing director at TORA in Hong Kong. “The trader only needs to worry about the uptick rule once the trigger price has been reached. Until that happens, you can short regardless of an uptick or downtick. This simplifies trading because it means that every order does not have to pass the uptick rule.
TORA has introduced enhanced short sale compliance functionality in its Compass product which will help buy-side firms adapt to the upcoming revisions to short sale regulations, by preventing users from breaching the revised uptick rule once the trigger price is hit.
Jenkins said that firms that have an execution management system equipped to process the short sell status data from market data providers, and that provide the user with simple workflows for complying with the uptick rule will be in a better position to manage short selling of securities whose price drops 10% or more within one trading day.
The new rule will also cover proprietary trading systems (PTS) and secondary listing exchanges. If a product is triggered on the primary exchange, then all PTS and secondary listing exchanges must also activate the uptick rule on the following trading day. When the trigger price is reached on a PTS, only the exchange is required to apply the price test intraday.
The new rules will also lead to a change in the reporting and public disclosure requirements on short positions. Firms had been required to report and publicly disclose all short positions above 0.25% of the issued shares of a security. Now, sellers will have to report a short position once it reaches 0.2%, and send a public disclosure once the position reaches 0.5%.
“At a more macro level, these changes reflect a balanced approach by the FSA to manage the potential risk of short-selling, while recognising the positive impact it can have on liquidity and price formation,” said Jenkins. “On the risk management side, the FSA will make permanent the measures that were successfully implemented in the US and Europe to reduce the effect of practices such as naked short selling, which are viewed as destabilising to the market.”