When is Short Selling legal in Australia?

This is an explaination of Short Selling in Australia. There are relevant provisions included from the Corporations Act 2001 and the ASX Trading Rules.

Options contracts on ASX

Corporations Regulation 7.9.79(1)(a), where it “does not have effect in relation to a sale of financial products that is done by the giving or writing of an option registered with: (a) an Options Clearing House Proprietary Limited“.

s 1020B(2), which states, “a presently exercisable and unconditional right to vest the products“.Here, the Act is referring to a situation whereby a sequence of short sales would be deemed legal if it is executed under an options contract

Options over futures contracts on SFE

Corporations Regulation 7.9.79(1)(b), where it “does not have effect in relation to a sale of financial products that is done by the giving or writing of an option registered with: (b) a SFE clearing Corporation Pty Ltd”.

s 1020B(2), which states, “a presently exercisable and unconditional right to vest the products”. Here, the Act is referring to a situation whereby a sequence of short sales would be deemed legal if it is executed under an options contract.

Arbitrage

Arbitrage transaction pursuant to s1020B (4)(b) & ASX Market Rule 19.2 which permits arbitrage transactions to occur as long as the Trading “Participant” – s761A which defines this as “a person who is allowed to directly participate in the market under the markets operating rules” – “is a registered arbitrageur” & sells the products on “bona fide (in good faith) arbitrage account on another market”.

Therefore, in the above sequence of short sales the arbitrageur will buy a stock on a foreign exchange which hasn’t adjusted for the exchange rate. The arbitrageur will purchase the undervalued stock and short sell the overvalued stock, thus profiting from the difference.

Offsetting contract to buy – unfulfilled conditions (s 1020B(4)(c))

“before the time of sale has entered into a contract to buy those products and who has the right to have those products vested in the person”

Where payment, receipt by the person of a proper instrument of transfer and the documents of title are present

This situation will arise when a trader already has a contract to buy (ie go long) on a particular stock

The short sale will subsequently counter balance the contract to buy with the contract for the quantity to go short.

Tick test

Restrictions on when a short sale may be executed. Tick-test rules dictate that a short sale can be made only in two situations:

1. When the price of the particular stock is higher than the last trade price (an uptick).

2. In a case where there is no change in the last trade price. The previous trade price must be higher than the trade price that preceded it (a zero uptick or zero plus tick)

This rule is intended to prevent investors from destabilizing the price of a stock when it’s falling. Also known as the short sale rule

Example

THE ENDING PRICE > STARTING PRICE is LEGAL

THE ENDING PRICE < STARTING PRICE is NOT LEGAL

Approved short sale products

Under [s 1020B(4)(e)] the legal notion of short selling is permitted if (i) “the products are included in a class of products in relation to which there is in force a declaration, made by the operator of a licensed market as provided by the operation rules of the market, to the effect that the class is a class of products to which this paragraph applies; and (ii) made as provided by the operating rules of the market; and (iii) at the time of sale, neither the person who sold the products, nor any person on behalf of whom the first-mentioned person sold the products, was an associate, in relation to the sale, of the body corporate that issued the products”.

Short Selling Market Rules

The issue of the “operating rules of the market” in relation to the shares in question would need to be classed under Section 19 of the ASX Market Rules: Short Selling -Traded products

19.3-19.7 highlights the “permitted short selling of approved short sale products and public securities”. However, it is under the rules of 19.7.1 which short selling is most relevant

Here, it states, “ASX may designate a Traded Product to be an Approved Short Sale if (a) 50 million Traded Products of the class have been issued; (b) the market capitalisation of the Traded Products of the class on issue is not less than $100million”.

Thus, if this series of short sales satisfies s 1020B(4)(e) in conjunction with section 19 of the ASX Market Rules, it shall be deemed legal.