fbpx
 

Shortselling

Source: Finanstilsynet

Shortselling

updated d. 06-09-2020

Short selling in denmark

The financial markets are important for the Danish economy. If they are well-functioning, they contribute to the efficient dissemination of credit and capital, and to companies being able to get the necessary capital to support their activities and growth opportunities. Well-functioning financial markets thereby contribute to Denmark’s prosperity.

 

Short selling, ie. where a market participant sells a security that he or she does not own is used for e.g. to speculate in price declines and uncover specific risks. Applications for short selling can contribute to well-functioning financial markets and to reducing risks in the financial sector. Conversely, there is a risk that short selling, especially in stressed markets, may contribute to instability and amplify negative financial fluctuations.

 

In recent years, the focus on short selling has increased significantly, both internationally and in Denmark. In addition, investors, especially from abroad, have significantly increased their short-selling activity in Danish equities. However, short selling has long been a common practice in the US and UK markets.

 

Against this background, the Danish Financial Supervisory Authority has focused on:

  • How short selling takes place in practice
  • Advantages and disadvantages of short selling
  • Scope and use of short selling on the Danish stock market
  • Rules for short selling in


What is short selling?

When an investor takes a so-called “short position” in a security, e.g. a share or a bond, it basically means that she is selling a security that she does not own at the time of sale. This is in contrast to an ordinary securities trade, where the seller owns the security that she sells. The investor with the short position is called the “short seller”.

Even if the short seller does not own the sold security, she must still be able to deliver it to the buyer. This can be done because the short seller has borrowed the security from another investor, e.g. an investment fund that owns the paper.

 

In order to borrow the security, the short seller has entered into a contractual obligation with the lender to return the borrowed security at a later date. In addition, the short seller pays interest to the lender and provides collateral in the form of cash or other securities.

 

When the short seller has to return the borrowed security, she buys it in the market at the current price and delivers it back to the lender. The short seller gets his collateral back on delivery.

 

Return of borrowed securities typically takes place due to contract expiration, ie. to the time agreed upon when the contract was entered into. In some cases, however, the return takes place before the agreed time, because the lender demands the security back.

 

Securities lending thus gives certain investors an alternative to having their securities in custody, as the interest and mortgage received allows them to increase their earnings against limited risk.

The process described above is illustrated in Figure 1 by short selling a stock.

Note: The numbers indicate the order of the individual events. Note, however, that interest payments to the share lender typically occur on an ongoing basis rather than at the time the contract is entered into.

In principle, investors may only sell securities in their possession at the time of trading. A short seller must therefore have been able to borrow the security before the sale or in a similar way secured himself to be able to transfer ownership of the security. In other words, short positions must be covered. Uncovered short positions, ie. where the short seller does not hold the security at the point of sale is regulated by the short selling regulation, cf. below.

Short positions generally cover the wider process of a physical securities market described above. Physical securities markets refer to financial transactions in which the actual securities are transferred between the parties to a trade. A physically short position in a given share or bond thus requires a loan and a sale of the actual security.

 

In addition to the physical markets, there are also synthetic financial markets. In synthetic markets, real securities are not traded directly. Instead, derivatives are traded, which are financial instruments characterized by not having an actual asset, e.g. a stock, behind them, but that they simply replicate the cash flow and value development of another instrument. In this way, short positions can also be taken at e.g. purchase of credit default swaps (CDSs) as well as sales of futures contracts and groups of i.a. exchange traded notes (ETNs) and contract for differences (CFDs). Common to them all is that their returns depend negatively on the value of the underlying assets and that their cash flows can be roughly replicated using physical short selling as shown in Figure 1.

Why Perform Short Selling?

Financial market players may have different reasons for taking a short position in a security. Short selling is typically done in order to:

 

a. profit on a falling price

b. hedge exposures to specific risks

c. facilitate trading and liquidity (so-called “market making”) in the relevant securities.

Profit From A Falling Course

If an investor expects a security to fall in price, she will expect to be able to make money by taking a short position in the security. This is done by borrowing the security and selling it. She then waits for the price to fall, buys the security and delivers it back. Thus, she has earned the difference between the selling and buying prices minus the interest for having borrowed the security, cf. Chart 2.

Note: The figure shows a constructed example of the price development in a security. The short seller first borrows a security, which she sells in the market at a price of 30. After a fall in price, the short seller buys the security at a price of 15 and delivers it back to the lender. The short seller’s profit thus becomes 15 (30 –

15) less interest on the lender and other costs.

However, there is a risk that the price of the borrowed securities – against the short seller’s expectation – will rise. In that case, the short seller will incur losses as she has to buy the securities back at a higher price than she sold them for.

 

Certain securities, e.g. shares, in principle do not have an upper limit for price increases. Thus, the short seller’s risk of loss is not limited in the same way as when you own a share, where you can at most lose the value of the share. It is therefore generally more risky to have a short position in a security than to own it. This is one of the reasons why it is the relatively more risk-averse hedge funds that are most active in short selling.

Identify Exposures Against Specific Risks

An investor can choose to take a short position to reduce its exposure to specific factors, e.g. a particular type of risk or a particular business sector. Short selling thus gives investors a better opportunity to put together their portfolios by being more able to adapt and manage their exposures.

 

For example, an investment bank that has a larger portfolio of corporate bonds and wishes to reduce its exposure to credit risk may for a period choose to have a short position in the same corporate bonds, e.g. by purchasing credit default swaps. The bank thereby reduces credit risk by owning these corporate bonds, but retains other risks associated with the bonds, e.g. market risk. Short selling can thus be an attractive one

and targeted way to adjust its overall risk exposure. Alternatively, the bank would otherwise have to sell its corporate bonds, and thus the bank would lose all of its exposure to the bonds and not just avoid the credit risk.

Facilitate Trade and Liquidity (Market Making)

Short selling can be used in connection with market making. Market making refers to a market participant, typically a bank, that sets buying and selling prices in a security and thereby increases liquidity in order to make it easier for other investors to trade the security.

 

In its function as a liquidity intermediary, a market maker may choose to sell a security that it does not have in its own portfolio at the time of sale. In other words, the market maker takes a short position in the security.

 

Market makers can choose to take short positions because they are otherwise limited to selling only securities from their own holdings. If market makers do not take short positions, it could potentially happen that they are prevented from executing a client order quickly and efficiently because they do not have the security in their own portfolio. Market makers’ use of short selling therefore helps investors to quickly buy and sell financial instruments.

 

Because market makers simultaneously buy and sell the same securities, they typically only have short positions for a limited period of time. This is in contrast to hedge funds, whose short positions typically run over longer periods depending on the investment strategy.

 

Due to the market makers’ function as liquidity intermediaries, market makers are the only players in the European financial markets who, pursuant to the Shortselling Regulation, may take uncovered short positions, cf. below.

Advantages And Disadvantages Of Short Selling

Socio-economic benefits

The ability to take short positions in securities can contribute to the well-functioning and liquidity of the financial markets. A liquid market is characterized by the fact that market participants can quickly and at any time complete larger trades at low cost and with only a small impact on the price.

 

Short selling can thus increase the securities’ marketability and availability to other investors, which supports market liquidity and price formation.1 (Among others, both Beber, A. & Pagano, M. (2010) find. Short-Selling Bans around the World: Evidence from the 2007-09 Crisis. Tinbergen Institute Discussion Paper, No. 10-106 / 2 / DSF 1 and Diamond.)

 

This happens, for example, when a short seller borrows securities

in order to take a short position. As a result, the lender’s securities are no longer in custody, but instead enter the market and are traded.

 

Similarly, short selling allows market makers to offer their customers (retail customers as well as institutional customers) to buy a security, even if the market maker cannot obtain the paper from its own portfolio or via the market at the time of the customer’s order.

In addition, short positions can potentially improve price formation in the market, as they can serve as an information signal about specific investors’ expectations of a particular security.

 

For example, short positions will signal to the market that there are investors who are so confident that the price will fall that they have been willing to invest in it – and thus risk losing money if they make a mistake. This may cause other investors to reconsider their share price. Therefore, if they agree with the short sellers that the stock price is overvalued, the price will fall. Short selling may thus have helped to accelerate a price adjustment.

 

For a shareholder, it can thus immediately look as if it is the short positions that cause the price to fall. This can lead to dissatisfaction with short selling, although there are some other underlying reasons that are to blame for the lower price.

 

For company management, the information signal about short selling can have a disciplining effect. Management knows that there is a risk that the company’s shares will be shorted if they make bad choices. In that case, it is clear to the shareholders and the market as a whole that someone assesses that the management has not done its job properly. To avoid getting into that situation, it can cause management to make more informed decisions, improve communication, etc., which can contribute to the company being more well-run and the stock price higher.

Finally, the use of short positions to hedge can reduce the overall risk in the financial system. If the financial companies use short selling to adjust and diversify their individual risk exposures, the individual institutions will, all other things being equal, become less vulnerable to major shocks to the financial markets, just as systemic risks are limited.

Socio-Economic Disadvantages

At the same time as there are socio-economic benefits of short selling, it also has the potential to increase the systemic risks, e.g. by being able to amplify financial instability and put pressure on already stressed markets. This is especially true for securities issued by companies, whose business model largely depends on trust in the company’s robustness and solvency, e.g. a bank that finances itself on an ongoing basis in the financial markets.

 

For example, short selling can have negative socio-economic consequences in periods when the price of one or more securities falls. The price falls can cause the market’s confidence in certain companies to fall, which can have a negative effect on their business operations. For example. It may be more expensive or more difficult for a bank to refinance its loans. As a result, short sellers may have an expectation of continued price declines and therefore choose to take new short positions in the securities in question, ie. they borrow shares and sell them. This increases the sales pressure in the markets, which all other things being equal leads to a further downward pressure on the price and confidence in the company. This can cause other investors to take short positions in the security, and a self-reinforcing negative spiral arises with potentially negative consequences for financial stability. It was i.a. For this reason, several countries, including Denmark, introduced a ban on short selling in all or parts of the national financial markets in connection with the financial crisis.

 

In the same way, turmoil in the derivatives markets can have a contagious effect on the physical securities markets, ie where the actual, underlying securities are traded. For example, a large price fluctuation in the derivatives markets could potentially lead to market participants taking large short positions in the physical markets in an attempt to hedge their other positions or create returns on price differences between the synthetic and physical markets. This may give other market participants an incentive to also act inappropriately, thereby increasing instability, all other things being equal.

 

Short selling can also help to increase interdependence between financial players. This happens especially in a physically short position, where the lender is exposed to the risk that the short seller will not return the lent security. Thus, a securities lender may suffer losses in stressed markets if the securities lent are not returned and the value of the pledged mortgage falls before the mortgage can be sold. Stress from the securities lender can then be spread and amplified to other financial players via its connections and obligations.

Short Selling On The Danish Stock Markets

Very large increase in short net positions in Danish equities

At the beginning of 2018, the value of short positions in Danish listed shares was approx. 25 billion DKK, corresponding to approx. 1 pct. of the total value of the Danish listed stock market, cf. Chart 3. p

Kilde: Finanstilsynet

Chart 3: The Value of Short Net Positions in Danish Listed Shares Has Sixfolded Since 2013

Note: The figure shows the market value in Danish kroner of outstanding short net positions above 0.2 per cent. of the issued share capital in Danish listed shares by sector of the issuer company and the relative size in relation to the total market. The sector distribution is determined on the basis of GICS codes.

Source: Finanstilsynet.

In recent years, there has been a marked increase in the value of short positions in Danish equities, cf. Chart 3. The development has been driven in particular by short positions in pharmaceutical shares, where both market value and short seller activity have increased during the period.

The growth in the value of short positions is only partly due to the fact that the value of the Danish stock market has generally grown during the period. In relation to the value of the entire Danish stock market, the value of short positions has also grown significantly from around 0.3 per cent. at the beginning of 2013 to almost 1 per cent. early 2018, cf. figure

The share of short net positions in Danish equities has in recent years been above the EU level, which from the second half of 2015 to the second half of 2017 was between 0.6-0.7 per cent. of the market value.2

 

Short selling in Danish shares takes place primarily in the large companies and to a very limited extent in the small cap and mid cap segment, cf. Chart 4. Thus, 25 out of 33 shorted Danish shares were in the large cap segment, ie. for companies with a market value of more than DKK 1 billion. euro at the end of 2017. Only six of the shorted shares were in the mid-cap segments and only two were in the small-cap segment.

Figure 4: Short Positions Are Primarily In The Large Cap Segment

Note: The chart shows the number of shorted Danish shares at the end of the quarter (bars) and the end value of the short positions in per cent. of the total market value (dashes) by size segment. Small cap, mid cap and large cap shares are defined as shares with an average market value below DKK 150 million, respectively. between 150 and 1,000 million. euros and over 1,000 million. Euro.

Source: Finanstilsynet.

At the same time, there is a distortion towards large Danish shares, as the value of short positions in medium-sized and especially small shares constitutes a relatively smaller part of the segment’s total market value, cf. Chart 4. This may be an indication that short sellers prefer liquid shares. can quickly trade itself in and out. At the same time, it may be an indication that short positions must be of a certain size in order to be profitable, and that short sellers therefore choose large shares, where the individual’s short position only to a limited extent affects the price and turnover. (2 ESMA, 2018, Report on Trends, Risks and Vulnerabilities, No. 1. 2018.)

The number of unique investors with short positions in Danish listed shares has also increased significantly in recent years, cf. Chart 5. At the beginning of 2018, there were almost 80 unique short sellers in Danish shares with positions above 0.2 per cent. of the issued share capital (the threshold value for when they must report to the Danish FSA). Short sellers in Danish equities originate predominantly from the United Kingdom and the United States, cf. Chart 5. The same trend is also generally seen in Europe.3

Figure 5: The number of position holders has doubled from 2013 to 2018

Note: The figure shows the number of short position holders with positions above 0.2 per cent. of the issued share capital distributed in the position holder’s home country. The figures in the figure must be seen as a bottom line estimate, as the obligation to report short positions only applies to positions above 0.2 per cent. of the issued share capital. Positions below this limit are not included in the calculations, which is why there are potentially more short sellers in Danish shares than stated.

Source: Finanstilsynet.

The value of short net positions in Danish shares measured in kroner has gradually increased since 2015, cf. Chart 6. This is mainly due to the fact that large short positions are taken to a greater extent, which raises the average, just as a larger proportion of positions are higher. level than before. (3 ESMA, 2018, Report on Trends, Risks and Vulnerabilities, No. 1 2018.)

Chart 6: The value of short positions in Danish equities has risen

Note: The figure shows the distribution of average short net positions in Danish kroner for positions above 0.2 per cent. of the issued share capital. The figures in the figure must be seen as an overarching estimate, as the obligation to report short positions only applies to positions above 0.2 per cent. of the issued share capital. Positions below this limit are therefore not included in the calculations.

Source: Finanstilsynet.

EU-Rules for short-selling

The European Short Selling Regulation (SSR) lays down the common European rules for short selling securities issued in the EU. SSR aims to make the use of short selling in European securities more transparent and to limit the instability that short selling can lead to in stressed financial markets. SSR entered into force in Denmark on 1 November 2012.

 

The SSR was designed in part because during the financial crisis, European Member States reacted differently to the use of short selling in securities under their supervision. Particularly for Member States that introduced temporary bans on short selling, the scope and duration of these bans varied markedly across markets. The harmonized set of rules for short selling in the EU has thus i.a. aimed at reducing the volatility and fragmentation of European financial markets during periods of financial stress.

Overall, SSR has three main elements:

a. Reporting and publication of short positions

b. Prohibition on the use of uncovered short positions and the market maker exemption

c. Temporary bans on short selling in specific securities.

a) Reporting and publication of short positions

Increased transparency contributes to leveling out information differences in the securities market and thus to more well-functioning markets. It also makes it easier for national and European regulators to monitor the use of short selling and to take the necessary measures in the event of abuse or the accumulation of systemic risks.

 

Against this background, SSR demands that short sellers with a short net position above 0.2 per cent. of the issued share capital must report their position to the relevant supervisory authority. In Denmark, it is the Danish Financial Supervisory Authority. At the same time, a short seller’s short position must be made public to everyone if it exceeds 0.5 per cent. of the issued share capital.4 Both short selling made physically and synthetically, ie. through derivative contracts, counts in the statement.

 

This information allows both the financial markets and the supervisory authorities to monitor short selling activities over a certain size.5

 

b) Prohibition on the use of uncovered short positions and the market maker exemption

Uncovered short positions are generally prohibited by virtue of SSR. Ie. you may not sell a security without first making sure that you can deliver the paper to the buyer. The purpose of the ban is to ensure that a buyer gets her papers on time once she has purchased them. It also helps to increase confidence in the markets.

 

Market makers are, however, exempt from the ban on uncovered short positions if they act as market makers in the securities and thus in their use of short selling intend to facilitate securities trading and contribute to liquid and well-functioning markets, cf. above.

4 Short positions in Danish government bonds are not subject to disclosure requirements. They must only be reported to the Danish FSA if they exceed a current threshold value, which is updated quarterly and which depends on the total nominal value of outstanding Danish government bonds.

5 The Danish FSA regularly publishes position holders on its website with short net positions above 0.5 per cent. of the issued share capital. In addition, the Danish Financial Supervisory Authority publishes the aggregate short positions above 0.2 per cent. in listed Danish shares, cf. https://www.finanstilsynet.dk/Lovgivning/In-formation-about-selected-supervisory areas / Short-selling / Published positions

a) Temporary bans on short selling in specific securities

SSR gives national regulators and the European Securities and Markets Authority, ESMA, the right to impose temporary bans on short selling in specific securities under their supervision.

 

The national and European authorities thus have the option of suspending short selling in a specific security across the EU if they assess that short selling in the paper causes or intensifies market turmoil. The ban on short selling in European shares under SSR has only been applied to a very limited extent and not for shares listed in Denmark.

FAQ

Learn more about short-selling

When you want to short a stock, you place a completely normal sale order, but you choose a stock that you do not already have in your custody.

Nordnet lends the share to you completely automatically. When you want to close your position, you simply place a buy order on the same stock.

Short trading can be used to reduce market risk. If you have a long-term equity portfolio, short trading can be a good alternative to selling out of the stock when the stock market is turbulent.

An example:
You have a stock portfolio with 7 different stocks and you want to reduce your risk in the market. The stocks you have in your portfolio, you think, have long-term potential and therefore you choose to keep them. Instead, you short out 3 stocks that you experience as overvalued and that you think will fall in value.
If the stock market subsequently falls further, you will make money on the shares you have sold short, thus reducing your losses. This reduces the total market risk in your portfolio.

If you want to reduce your risk in the market further, you can, for example, choose to sell two of your shares and sell another 5 shares short. If you have 5 shares in the depository and go short in 5 other shares, you can say that you are market neutral.

Shorting stocks is an opportunity to make money in a falling market or by falling prices in individual stocks. Shorting means that you as a customer sell shares that you do not own.

When you sell shares that you do not own, Nordnet automatically takes out a securities loan for you to be able to deliver the shares to the buyer. Once you have shorted shares, you will make money when the price of the stock falls and lose money when the price of the stock rises. Exactly the opposite of an ordinary stock purchase.

When you later choose to buy back the shares that you have shorted, Nordnet will automatically return the shares to the lender. However, in the case of short trading, where you sell and buy back the shares on the same day, no securities loan will be taken out.

You pay an administration fee for securities loans, and you pay interest during the period you are shorted in a share. The brokerage when you sell shares in short trading is the same brokerage as in ordinary stock trading.
Note that dividends paid during the loan period accrue to the lender. The same applies to. subscription rights etc.

If you short a share on the same day as the dividend is paid, you have a duty to repay the dividend to the original owner of the share. Dividend is paid to the person who owns the share at 00.00 on the day of the general meeting. This should be taken into account before you consider being short in a stock over the day of the general meeting.

Click on the links below to see when general meetings are held in the markets where you can short shares:

Denmark

Norway

Sweden (general meeting = annual general meeting or general meeting)

Example:
You borrow 50 pcs. CARL B the day before the general meeting, sell them short and leave the position short after the stock exchange closes. The new owner, who is the holder of the share on the day of the general meeting, is entitled to the dividend of e.g. DKK 6 per shares. This is paid directly to the new owner from the limited company.

At the same time, however, you have still borrowed the share, and therefore the original owner is also entitled to have the dividend paid out by you. In this case 50 pcs. dividend for CARL B of DKK 6 per share = DKK 300. The amount Nordnet will deduct from your account and ensure that it is transferred to the original owner.

More information can be found in the General Terms and Conditions for Securities Loans (pdf) under point 9.

Yes. In short trading, you speculate in price declines, and your potential profit becomes greater the closer the share price approaches zero. However, should the price rise instead, there is in principle no limit to how much the share can be worth, and thus also not to how large your loss can be. It is therefore very important to actively monitor the market in short trading.

There is also a risk that securities loans may not be taken out or that the lender will demand its shares back. In that case, the shares must be repurchased. In the event of a dividend payment, it will be you who must pay the dividend to the lender of the shares if you have a short position in the share.

Normally, when dividends are paid, a share will, all other things being equal, fall by the value of the dividend, but it is often speculated that the share does not fall as much as the size of the dividend. It can therefore be extra risky to be shorted in a share when dividends are to be paid.

As you sell shares that you do not own through short trading, Nordnet borrows the shares in the market at your expense. This happens completely automatically and you will see the securities loan in your custody the day after your short trade. You pay a fixed fee for the securities loan, for which you must pay interest during the period in which you are shorted in the share.

NOTE: You only have to pay interest and administration fee for the securities loan after the short trade has been completed if the repurchase is not completed on the same day as you have shorted. In other words, you do not have to pay for the securities loan if you short and buy the share on the same day.

When you short, you complete a sale in the same way as if you owned the stock. All you have to do is sell a share that you do not have in your custody account, and you repurchase the share exactly as in a normal purchase transaction.

A thought up example:
You do not own any shares in Vestas, but you believe that the share will fall in value. To complete a short trade, you therefore choose to sell 1000 shares at a price of 255, a total value of DKK 255,000.

After the sale, you will see an inventory of -1000 pieces in your deposit overview. Vestas shares. The day after your short trade, you will see an entry in your deposit on the securities loan and you will automatically be charged a fixed fee for the securities loan. The week after your sale, the price has dropped to 234, and you therefore choose to claim your winnings.

You now buy 1000 pcs. Vestas shares in the market as a normal purchase order, and you thereby close your shorted position in Vestas. Nordnet then automatically returns your borrowed shares to the lender, and you will then be charged the interest on the securities loan for the period you have borrowed the shares. Your gain can thus be calculated at 255,000 – 234,000 = DKK 21,000.

minus afdrag for kurtage, afgift for værdipapirlån og rente.

Yes, in the case of short trading, security must be provided. At Nordnet, a margin requirement of 15-100% or a negative collateral value corresponding to 115-200% of the market value is required. If you with a cash balance of e.g. DKK 50,000 will short a share with a margin requirement of 20%, you will be able to short / sell shares to a value of DKK 250,000.

However, in order not to have to close the position at an unfavorable price, it is recommended to have good margins in short trading

When you place a sell order to short, the trading system checks that there is sufficient security in your deposit in the form of cash and / or collateral value. The collateral requirement is 115 – 200% of the market value of the shorted share. This means that the amount in “Available for Trading” will decrease by an amount equal to 15 – 100% of the market value of the shorted share.

When repurchasing a shorted position, this purchase order is treated exactly like a regular purchase, thus charging the amount in “Available for Trade”. This means that if you have gone short but want to be in a positive position in the same stock, you must first buy a number of shares that corresponds to the number you are short in before a new purchase order can be placed to buy more equities. However, this only applies if the depot does not have coverage for both security requirements and purchase orders.

Short trading via the internet is limited to a market value of a maximum of DKK 10 million for the shorted positions.

According to a judgment in the National Tax Court, gains and losses from short trading in shares must not be taxed in the same way as gains and losses from ordinary share trading. The Capital Gains Tax Act is based on the fact that profits are found on the acquisition and subsequent sale of shares.

The National Tax Court therefore considers that a gain that is linked to a period in which the taxpayer has not been the owner of the shares cannot be considered covered by the Capital Gains Tax Act.

Therefore, short trades are not covered by the Share Taxation Act, but instead gains and losses on share loan schemes, including short trades, are covered by the Income Taxation Act (Section 4 (f) of the State Tax Act).

In other words, short trades must be declared as income and the net gain on short trades is taxable, while losses are not deductible.