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Home > Media Reiews > News Review Last Updated: 14:52 03/09/2007
News Review #9: February 28, 2002

Japanese FSA clamps down on short selling

Reviewed By Hitoshi URABE

"Japanese FSA clamps down on short selling"
Financial Times, February 26, 2002

Short-selling is a legitimate market transaction, at least in theory. There is nothing wrong with short-selling, which is to make a contract in the securities market to sell securities you do not own. You would of course have to fulfill the contract, and deliver the securities to your counterpart eventually, either by purchasing them elsewhere, or by borrowing them. The risk of price fluctuation is borne by the seller, or, looking at it the other way, the seller can seek an opportunity to make money, a natural and respectable motive to participate in the market. Logically, these players would be functioning as a vital element to maintain liquidity and resiliency in the market.

That's how the theory dictates, but in reality, short-selling is restricted in one way or another in most of the developed financial markets. The reason for the regulation is based on the fact that short-selling has no built-in mechanism to limit the volume, hence loss, of the transaction a player can execute. Protecting the market from a reckless behavior is the purpose of imposing a certain level of restriction.

Regulations can be fine-tuned to suit the needs of the participants while maximizing the benefit of market mechanism, that is, all can be confined within the professional circle. It gets complicated, however, when amateurs becomes involved, especially when they have power, such as legislative power.

It is sometimes difficult for a layman to understand that short-selling is a very natural and decent transaction in a financial market. They see things ethically; that selling something you do not have is improper, if not fraudulent. Combine this sentiment with a false proposition that short-selling itself would be a cause of stock price dwindle, and the naive legislators begin to believe that levying restrictions would help preserve the stock prices while also serving social justice.

The professionals in the market should become aware that the abuse of market rules would only lead to further, and often undesirable, restrictions, and that it is their responsibility to protect the free but fragile market.

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