Emerging Market Short Sales: Ambrosia or Kryptonite?

1
Emerging Market Short Sales Ambrosia or
Kryptonite?

• Edward Pekarek, Esq. and Maryam Meseha

2
Reading Questions

• What are the benefits and risks associated with
  short selling in emerging markets?
• What must I be aware of before short selling in a
  particular emerging market?
• Do certain markets pose greater risk than other
  markets?
• Do various restrictions on short selling pose a
  incontrovertible barrier to my investment?
• Are there other options available to bypass the
  barriers to short selling?

3
Summary

• This chapter surveys the nature of short selling
  in various emerging markets, specifically the
  BRIC nations, and identifies various advantages
  and risks associated with bearish trading in
  emerging markets.

4
Introduction

• This survey focuses on what are widely considered
  to be the leading emerging markets, specifically
  the so-called BRIC nations, Brazil, Russia,
  India, and China.
• This chapter is designed to educate the reader
  regarding some of the basic essentials of short
  selling in emerging debt and equity markets.

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Analysis Benefits of Short Selling

• Fosters capital-raising because short selling
  frees up capital that may have been otherwise
  allocated to long positions during periods of
  market appreciation
• Provides a means by which markets can segregate
  underperforming companies and identify mispriced
  securities through bearish information diffusion
  and transfer
• Increases market liquidity.

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Analysis Criticisms of Short Selling

• Possible price manipulation
• Believed to disrupt otherwise orderly markets
  through panic selling and resulting high
  volatility which can destabilize an economy
• Facilitates severe price declines in individual
  securities.

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Short Selling in Brazil

• Brazil permits short selling but imposes specific
  restrictions based on the citizenry of the
  investor.
• Brazil imposes restrictions on foreign short
  sellers by requiring them to have a legal
  representative stationed in Brazil.
• There is no indication that Brazil will lift this
  heavy restriction in the near future.

8
Short Selling in Russia

• Russia has explicitly regulated short selling
  since 2002
• In 2008, Russia announced that it would ban
  margin selling and short-selling altogether in
  response to the worlds financial downturn
• As of May 2010, these bans appear not to be
  lifted.

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Short Selling in India

• Indias regulatory system allows for short
  selling but it is rarely practiced
• Foreign institutions are prohibited from short
  sales but individual investors may make bearish
  wagers without restrictions.

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Short Selling in China

• Short selling was prohibited in Hong Kong prior
  to 1994
• Chinese officials lifted restrictions on March
  25,1996, and allowed all of 113 Hang Seng stocks
  to be shorted without restriction
• In the wake of the world financial crisis of
  2008, China permitted short selling in order to
  boost trading.

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Short Selling in Other Key Markets

• South Korea
• Has an increased tolerance for short sales but
  South Korean market regulators have announced
  that they will tighten monitoring in order to
  curb volatility.
• Indonesia
• Previously permitted investors to sell short
  approximately 50 major issues that trade on the
  bourse
• It temporarily banned both covered and so-called
  naked short sales on October 1, 2008 for
  30-days in response to the recent economic
  crisis
• Lifted the ban in part on February 4, 2009 and
  revised its short sale and margin trading
  regulations with an effective date of May 1,
  2009.

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Short Selling in Other Key Markets

• The United Arab Emirates
• Announced in October 2010 that it would introduce
  short selling.
• Eastern Europe
• Largely overlooked by many investors
• Can be a profitable investment region and may
  generally is not affected widely by short selling
  constraints

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Helpful Investor Mechanisms

• Must identify an emerging market with an
  efficient lending system
• Must identify an emerging market with less
  cumbersome lending rules
• Be aware of an emerging markets regulatory
  system
• Avoid these problems altogether investing in ADRs
  or ETFs.

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Conclusion

• This chapter provides only a survey of various
  policy considerations regarding short selling in
  various emerging markets
• The benefits and risks vary by nation with regard
  to emerging market short selling and investors
  would be well served to research the selected
  locales
• Short selling policies in the BRIC nations vary
  widely, often based on political events and
  climates, to such an extent that any investor
  considering such an investment strategy must
  become familiar with the market before accepting
  the risk of unlimited losses that short selling
  poses.