Canadian regulators consider rules to reveal identities of short sellers and details of their trades

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Canada’s securities regulators are considering whether the identity of short sellers, as well as the details of their trades, should be publicly disclosed when they take a significant position in a Canadian company.

A coalition of Canadian regulators issued a notice Thursday asking market participants if they would support stricter transparency rules being imposed on short sellers, including disclosing their names and trading positions to the public whenever they make a significant short sale.

The notice is part of a broader review of short selling – one of the most polarizing issues in the capital markets – by the Canadian Securities Administrators, the umbrella group for the country’s provincial and territorial securities commissions, and the Investment Industry Regulatory Organization of Canada (IIROC).

Short selling is a bet that the price of a stock will decrease. A short seller who believes a company’s stock price will decline borrows shares and sells them. After time passes, the short seller purchases shares in the market at what they hope will be a lower price, replaces the borrowed shares and pockets the difference.

Short selling is practised by all manner of market participants, but the most well-known players are sometimes referred to as activist short sellers – those whose trades coincide with a publicity campaign aimed at exposing alleged problems at a public company.

Over the past few years, a number of organizations have taken aim at several aspects of how Canada regulates short selling. Last year, Ontario’s Capital Markets Modernization Taskforce called for tougher rules to ensure short sellers have borrowed shares in place before they execute a short trade. A comprehensive report by Bay Street law firm McMillan LLP in 2019 described Canada as a “haven” for activist short campaigns.

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But a Thursday update from the CSA paints a slightly different picture, using the most recent data. In 2022, seven Canadian public companies have been targeted by activist short-selling campaigns, but over the same period in the United States, 50 public companies found themselves in the sights of activist short sellers, the report states.

The CSA found that, annually, less than 1 per cent of all Canadian issuers were the focus of an activist short-seller campaign, while 3 per cent of all U.S. issuers and less than 0.5 per cent of Australian issuers were targeted by such campaigns.

In a section titled “perception versus evidence,” the CSA said that, despite hearing from public companies, law firms and industry associations about how damaging short sellers can be, it stood by a previous statement that it could “not identify widespread market abuse related to activist short selling.”

However, in a joint notice with IIROC, the regulators said they are still considering tweaks to how all short selling – not just activist short selling – is policed. In line with the recommendations of the Capital Markets Modernization Taskforce, the regulators have asked market participants for feedback about tightening certain rules, such as introducing a strict requirement that short sellers have borrowed shares in place before they short.

As for whether short sellers should have to publicly disclose their names and trades, the regulators pointed out that a similar system exists currently in the European Union. They acknowledged there can be “unintended consequences” to such a system, including encouraging “group behaviour that would drive down a target issuer’s stock price.”

The CSA cited the example of Solutions 30 SE, an information-technology company based in Luxembourg. The company was shorted by well-known short seller Muddy Waters LLC, which, as required by European regulations, publicly disclosed its trade on May 17, 2019. Days later, Solutions 30 SE’s share price had dropped by 20 per cent, even though Muddy Waters had yet to release its short report, the CSA said.

In an e-mailed statement, Paul Davis, a partner at McMillan and one of the lead authors of the law firm’s review of short selling in Canada, said the regulators’ calls for input are significant.

“We believe that the steps taken by the CSA and IIROC today are important and consistent with our call for a thoughtful re-examination of the Canadian short selling regime,” Mr. Davis said.