SEC poised to shine light on short selling with stock loan disclosure

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Short sellers and other market participants will have to quickly disclose deals to borrow securities under rules expected to be adopted by US financial watchdogs this week as part of a broad regulatory push for greater market transparency.

Investors, typically hedge funds wagering that securities will fall in value — known as short selling — need to borrow stocks and bonds to make the bets before returning them to their owners.

Lenders of the securities profit by charging a fee for the borrowed assets. Some $1.8tn of securities are loaned annually in the US, according to data cited by insurance regulators.

The US Securities and Exchange Commission on Friday is scheduled to vote on whether to push ahead with its disclosure rule. As first aired in November 2021, the proposal would require securities lenders to report each loan within 15 minutes of the deal. Information on the loans, but not the names of the parties involved, would be made public.

The proposed regulations are the latest in what has proved to be the agency’s most active rulemaking blitz since the aftermath of the 2008 financial crisis.

The SEC earlier this week adopted rules halving the time investors have to report the build up of big stakes in companies from 10 days to five days.

Securities lending is considered one of the more opaque corners of the financial markets — a point highlighted during the meme-stock frenzy of January 2021, in which the number of shares borrowed in some companies appeared to have exceeded the total available.

While possible if securities are lent more than once, the situation prompted calls for tighter oversight. Better disclosure was called for in the Dodd-Frank financial reform law that followed the 2008 financial crisis, but were not developed by the SEC until its 2021 proposal.

The proposal has attracted pushback from investors and banks worried about meeting the reporting requirements and investors concerned that the information could disclose their positions.

“Making the securities lending markets more transparent will make them more efficient, and that’s not great news for some banks’ business models,” said Tyler Gellasch, chief executive of the Healthy Markets Association, which advocates for investors. “The compliance burdens and other costs need to be worked through, because putting all the burden on securities lenders will definitely create some new headaches.”

The Investment Company Institute, which represents the funds that do most of the securities lending, has warned that the 15-minute reporting requirements will layer on costs and make the practice unprofitable. They also warn rapid disclosures could make it easier for high-frequency traders to front-run investors.

“It’s important for us to help folks cover shorts . . . but when you impose all the costs, a lot of funds are just going to say, ‘Is it worth even engaging in securities lending?’,” said Stephen Bradford, ICI’s spokesperson. “It’s another example of the SEC citing expansive but vague benefits but giving very short shrift to the costs and the knock-on effects.”

The five-member SEC can decide to adopt the proposed rules as they stand or make adjustments. Some market participants have called for an end-of-day reporting requirement instead on the planned 15-minute window.

“That makes sense for securities loans. This isn’t your typical type of transaction that you have [on] an exchange or other type of platform,” said Ignacio Sandoval, partner at law firm Morgan Lewis, who described the deals as an iterative process. “It can take the entire day and not be finalised until the end of day. So then the question is, when are those terms really finalised? And at what point do you actually have a reportable transaction?”