While Regulation SHO currently targets naked short selling, enforcement and compliance often lags or is missing altogether, leading to persistent issues with naked short positions. Additionally, there are exceptions for market makers to provide liquidity which need to be tightly regulated to prevent abuse. Here are some specific details of requirements that should be implemented to address these shortcomings:
- Enhanced Transparency and Reporting:
-Mandatory Reporting: Require brokers to report short positions more frequently and with greater detail. This could include daily or weekly disclosures of short positions to regulatory bodies, which could then be aggregated and published to increase market transparency.
-Fail-to-Deliver (FTD) Tracking: Implement stricter monitoring and reporting of FTDs, where the seller does not deliver the securities to the buyer within the standard settlement period. Persistent FTDs could be a red flag for naked shorting. - Tighter Settlement Regulations:
-Shorten Settlement Cycles: Reduce the standard settlement time frame (currently T+2 in many markets) to T+1 or even same-day settlement (T+0). This reduces the window during which a naked short could remain unresolved.
-Penalties for Settlement Failures: Impose significant fines or sanctions for failures to deliver securities on time, which would discourage attempts at naked short selling. - Locate Requirement Enforcement:
-Pre-Borrow Requirement: Strengthen the ‘locate’ requirement where brokers must have a reasonable belief that the equity can be borrowed before allowing a short sale. This could involve a pre-borrow mandate where the shares must actually be borrowed before the short sale is executed.
-Hard Locate: Introduce a system where a “hard locate” must be confirmed, meaning the shares are not just located but are actually set aside for borrowing. - Technology and Surveillance:
-Real-Time Surveillance Systems: Utilize advanced AI and machine learning systems to detect patterns indicative of naked short selling in real time. This could help in early detection and prevention.
-Blockchain or Distributed Ledger Technology: Explore the use of blockchain for stock trading to ensure a transparent and immutable record of transactions, which could virtually eliminate the possibility of selling something you do not own or have borrowed. - Global Coordination:
-Since financial markets are global, there should be an effort to coordinate these regulations internationally to prevent regulatory arbitrage where firms might engage in naked short selling in less regulated markets. - Education and Awareness:
-Educate investors about the risks and mechanics of short selling, including the illegal aspects of naked shorting. Informed investors can also act as another layer of market surveillance. - Legal and Regulatory Enforcement:
-Strengthen legal consequences for violations, including criminal charges for severe or systematic abuse. Enforcement agencies need the resources and authority to pursue cases effectively.
By implementing these measures, regulators can aim to eliminate or significantly reduce the practice of naked short selling while maintaining market fluidity and efficiency.