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Japan’s short-selling rules reform to improve liquidity
Japan is proposing to remove some of the restrictions around short-selling in a move that should have a flow-on effect to the securities lending market and overall liquidity in the Japanese sharemarket.
The main proposal is the removal of the ‘up-tick rule’, which prohibits short-selling at or below current prices – that is, the price has to be struck at least one ‘tick’ up from the latest price.
Japan introduced its up-tick rule in the 1940s just after the US introduced the same rule (the US dropped it in 2007). Japan then moved to ban naked short selling – where a stock is shorted without having been borrowed first to ensure it can be covered – in 2008, as a temporary measure, but this has remained in place.
The new proposals suggest that the up-tick rule should be applied only if a stock falls 10 per cent lower than the previous day’s closing price.
The Japanese Financial Services Agency has invited public comments on the draft revisions to restrictions on short-selling by April 8, with a view to implementing the changes in November.
The revisions also propose making the naked short-selling ban permanent and changes to the reporting and disclosure obligations for holders of short-selling positions of a certain scale.
Currently these obligations are both set at 0.25 per cent or more of the total number of shares outstanding, at which point holders must disclose their position to exchanges through securities companies which must make public announcements of that information.
The new rules propose the introduction of a two-tier model with 0.2 per cent as a reporting requirement and 0.5 per cent as a disclosure requirement.
Research has shown the restrictions have had a negative impact on liquidity in the Japanese market.
Jun Uno is a professor of finance at Waseda University and has published papers on the Japanese stock lending market.
His research, “Empirical Analysis of Japanese Stock Lending Market: Estimation of the regulatory effect on short-selling”, published jointly with Junya Umeno and Risa Muroi of BlackRock Japan, found the short-selling restrictions had a negative effect on the Japanese securities lending market.
The three studied the correlation between the liquidity of the lending market and the liquidity of the stock market.
“The higher the liquidity of stocks in the lending market, the larger is the number of transactions in the stock market, and their bid/ask spreads tend to become small and their depth tends to increase,” the paper concluded.
The interaction between the two has fallen off since the tighter regulations were announced in 2008, which was most likely a factor in the decline of stock market liquidity since then.
Uno’s paper also found changes in attitudes towards stock lending by index funds post the regulation changes.
 “It is possible that the announcement of a tightening of regulations on short-selling caused changes in, for instance, restrictions on arbitrage transactions and the stance of passive fund managers with regard to stock lending. The tightening of regulations on short-selling itself is also believed to have had an effect, albeit to a limited extent.”
– Penny Pryor
