Warsaw bucks trend on naked short selling

The introduction of naked short selling for instruments listed on the Warsaw Stock Exchange (WSE) in July will “change the landscape” for participants in Poland’s financial markets, according to the exchange’s head of derivatives.
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The introduction of naked short selling for instruments listed on the Warsaw Stock Exchange (WSE) in July will “change the landscape” for participants in Poland’s financial markets, according to the exchange’s head of derivatives.

Jaroslaw Ziebiec, director, financial instruments at the Warsaw Stock Exchange, said the new framework for naked short selling would narrow spreads and increase arbitrage opportunities on the exchange’s derivatives market and stimulate greater liquidity on its cash market.

“Previously you had to borrow securities first to do short-selling. Now, we are introducing a regulatory structure for naked short selling. In reality, there will be so many safeguards that it will not be the kind of ‘pure’ naked short selling that exists in other markets,” he said.

According to Ziebec, the new framework was agreed with Poland’s financial services authority in March and he concedes that “it would be tough” to secure approval in the current regulatory environment. In May, German financial regulator BaFin banned naked short selling on a number of securities in a bid to curb speculative trading. The Committee of European Securities Regulators, the body established by the European Commission to coordinate securities market regulation in Europe, has issued a proposal for pan-European regulation of the activity. “There are so many safeguards that it’s closer to covered short selling than pure naked short selling,” said Ziebec.

From 1 July, the exchange will introduce new rules which make it possible to take short positions in WSE-listed instruments within a framework approved by the Polish financial regulator that includes safeguards against settlement risk and excessive market volatility. Under the new regime, market makers and other liquidity providers will be able to short sell the 140 most liquid stocks on the WSE as well as treasury bonds issued by the National Bank of Poland, but market participants will be restricted to a smaller list of securities when trading on behalf of clients or on a proprietary basis. In this case, constituents of the WIG20 blue chip index, plus 16 other liquid stocks, and 40 treasury bonds will be available for short-selling initially.

Short-selling will also be permitted for large new issues on the WSE, from the middle of the next trading day following an initial listing. The WSE has issued a list of available securities which will be updated eight times a year to account for factors such as changes in the liquidity levels of individual stocks.

The exchange has also outlined a flexible framework for suspension of naked short-selling activity which can be implemented for the whole market, individual stocks or even specific functions conducted by a market participant, i.e. client or prop trading. Naked short selling can be suspended on advice from Poland’s National Depository for Securities (KDPW) in the event of increased settlement risk or by Poland’s financial services authority to maintain overall stability of the country’s financial markets. The WSE can also suspend naked short selling if the WIG20 index falls by 10% or more in value or if an individual stock price slips by 3% or more, but only if the decline is accompanied by a rise in short sale transactions to 20% of all market activity by value.

Previous short-selling rules were so restrictive as to limit activity to a minimum, according to Ziebec, who sees the new framework as fundamental to the exchange’s growth.

“Without short selling, it has been all but impossible for market makers in single stock derivatives to conduct arbitrage or hedging activity,” said Ziebiec. “Buying futures and sell stocks is not really possible without short selling. The new changes will also bring more liquidity to the cash market by allowing market makers to short sell in the morning and close positions later in the day, for example.”

The WSE traded 13.5 million derivatives contracts in 2009 and reported an average daily equity turnover value of €335 million.

Ziebec expects growth of naked short selling to be gradual and says he would be satisfied if it accounted for around 8% of market activity by the end of the year. He predicts an increase in trading interest from international players that currently do not trade in Warsaw as well as existing remote members.

The WSE has undertaken a number of activities to explain the short-selling initiative to market participants, including participation in a seminar held by Deutsche Bank’s domestic custody services business in London on 18 June.

“When we talk to large derivatives players in London, they mention the lack of arbitrage opportunities and short-selling is often raised as an obstacle,” he said.