Short-selling should be regulated as some practices may create disorderly markets during extreme financial turmoil, a global body of supervisors said on Monday.
Short-selling has been blamed by critics for exacerbating the slide in bank shares during the credit crunch.
And the International Organization of Securities Commissions (IOSCO) policymakers, who have put forward recommendations to deal with the issue, have pointed to hedge funds as they often use the tactic.
We believe that short selling should operate in a well-structured regulatory framework in the interests of maintaining a fair, orderly and efficient market, said Martin Wheatley, chairman of IOSCO's task force on short selling and also chief executive of Hong Kong's Securities and Futures Commission.
Several European Union countries introduced curbs last year unilaterally, drawing industry criticism over a lack of coordination in a single EU share trading market. The slide in many financial shares continued in spite of the curbs.
Belgium extended a ban on short-selling to June 1 on Monday and Hong Kong said it was likely to amend its short selling regulations.
U.S. legislation was tabled last week aimed at forcing regulators to reinstate an uptick rule designed to limit short sales of stocks after the 1929 stock market crash. The rule, which was repealed two years ago, will be reconsidered by the Securities and Exchange Commission in April.
The IOSCO said short selling helped to improve price discovery in markets, mitigate price bubbles and increase liquidity, but called for regulation based on four principles.
One type of short selling that the IOSCO is targeting is naked short selling whereby a dealer sells shares in a company without borrowing them first.
Wheatley said the regulation should reduce the potential destabilizing effect that short selling can cause without exerting undue impact on its legitimate benefits in capital formation and volatility reduction.
AIMA, a global hedge fund trade body, said IOSCO's report was admirably sensible and that it would welcome a more consistent global approach to regulating short selling.
At present, the many discrepancies worldwide create unnecessary uncertainty, AIMA Chief Executive Andrew Baker said in a statement. AIMA also backed disclosure of short positions to national supervisors.
Consultation will run on the IOSCO's recommendations until May. The main suggestions to regulate the practice are:
-- Short selling activities should be subject to appropriate controls to reduce the potential risks that could affect the efficient functioning and stability of financial markets. A minimum requirement should be strict settlement of failed trades;
-- Short selling should be subject to a reporting regime that provides timely information to the market or to market authorities;
-- Short selling should be subject to an effective compliance and enforcement system to monitor settlement failures or whether cross-border information sharing among regulators is adequate;
-- Short selling regulation should allow appropriate exceptions for efficient market functioning and development.
IOSCO comprises national market watchdogs from over 100 countries including the United States, the EU's 27 member states, Japan and Hong Kong. Its members agree to apply locally the principles and standards they adopt.
(Reporting by Huw Jones; Editing by Sharon Lindores)