Short selling

At present, only stocks specified by the Stock Exchange of Hong Kong ("SEHK") as Designated Securities Eligible For Short Selling can be sold short.

Selling a stock that you do not own is prohibited under the Hong Kong laws. The only exception is if, at the time of the sale, you honestly believe that you have a presently exercisable and unconditional right (such as the holding of options, warrants or convertible notes in the stock) to sell the stock.

A common practice is to enter into a valid stock borrowing arrangement with an existing holder of the stock and ensure that the stock lender has adequate shares to lend before placing a short sale. You can ask your brokerage to arrange this. However, for risk management purposes the brokerage lending the stock would ask for collateral of at least 105% of the value of the stock borrowed. The stock borrowing arrangement ensures that when the short sale is made, you have already acquired the right to the stock and will be able to settle for it on T+2.

When you place the order, you must tell your broker that you are selling short and confirm that you have a stock borrowing arrangement in place. You can make an oral assurance at the time of the order that it is a short sale and the stocks have been borrowed. However, you must:

i. tape-record this conversation and keep the tape as a record; or
ii. provide a time-stamped record of the assurance with particulars of the stock borrowing arrangement; or
iii. confirm the oral assurance in the form of a document within the same day.

(You can set up a stock borrowing arrangement with your brokerage: in this case, the brokerage will have to provide the records mentioned in (i) or (ii) above.)

It is a criminal offence to conduct short sales without declaring them to be so.

Short sales can only be executed through the SEHK's securities trading platform system. In addition, short sales cannot be made below the best current ask price, unless they are related to designated index arbitrage or are made by market makers in their market making activities or hedge the risk of their market making positions.

A placement of shares before its completion is generally subject to various conditions which may or may not be fulfilled, particularly that:
i. the Listing Committee of the SEHK grants the listing of and permission to deal in, the placing shares; and
ii. the SEHK does not revoke such listing and permission.

In other words, until the placement is completed and the conditions of the placement have all been fulfilled, the placing shares will remain conditional.

Under the Securities and Futures Ordinance, a person shall not sell securities at or through a recognized stock market unless at the time he sells them,
i. he has or, where he is selling as an agent, his principal has; or
ii. he believes and has reasonable grounds to believe that he has or, where he is selling as an agent, that this principal has,
a presently exercisable and unconditional right to vest the securities in the purchaser of them.

Some placees, be they investors or intermediaries, misunderstand that, before the placement is completed, they can sell placing shares for which they have subscribed, even if they do not have the shares when they place the sell order, under either of the following situations:

i. they represent that they could settle the trade on the settlement day with the placing shares allotted to them; or
ii. they rely on oral or written confirmations from their placing agents about the quantity of shares that would be allotted to their own Central Clearing And Settlement System (CCASS) account or to their broker's CCASS account as guarantees for receiving the same number of placing shares on the completion date to settle the trades.

The above view is not correct because at the time when the placees place the sell order, the placing shares in question are still conditional and hence, the sellers do not have a presently exercisble and unconditional right to vest the securities in the purchaser of them. If you sell these conditional placing shares before completion of a placement, you run the risk of committing illegal short selling unless you already hold a sufficient number of shares to settle the trade or arranged stock borrowing in advance.

Some investors think that it is legal to short sell a stock as long as it is bought back on the same day. This is wrong. Just because you can settle a short sale does not imply that the deal is legal. You must follow the procedures mentioned above.

You could take part in illegal short sales by mistake. How can this happen? You could make an error when calculating the number of shares you own. Or you might not realise that your shares had been consolidated so that the amount of shares sold was greater than the number of shares you owned.

If you do take part in illegal short sales by mistake, you can borrow the shares from the brokerage or buy them back from the market to fulfil the settlement obligations. If the short sale order means the brokerage does not have enough shares to fulfil its settlement obligation under the continuous net settlement system, the Hong Kong Securities Clearing Co. Ltd. will compulsorily buy the shares from the market on behalf of the brokerage to complete settlement. Brokerages will usually pass on the expense for this to their clients.

So, before placing a sell order, you must check with your broker whether you have enough shares to sell. You should also keep track of the number of shares you hold and any changes where there has been a share consolidation.