There is naked and then there is naked. Vigeland’s sculptures in Frogner Park, Oslo are undoubtedly naked and a worthwhile visit.
But what is a naked short sale? As the EU consultation period on short selling draws to a close I’m not convinced that this has been properly defined. I have always considered that a naked short sale is one where the seller has no intention whatsoever to borrow the share or bond in order to settle the transaction on the due date and has no concern for the fail their actions will cause. If this is the activity the EU is attempting to curb then I think most market participants ( with the exception of naked short sellers) will be on board. Is this the correct definition?
Market makers are temporarily naked short all the time and provide huge liquidity to the system and while they are intended to be somewhat “exempt”, how will we distinguish between their activities and other traders? Is being naked short on a transaction with a settlement cycle of T+3 permitted for two of those days as long as you settle on day three? If not then will all fails be considered as a result of naked shorting and incur penalties?
There are consequences to addressing this via settlement penalties too. Greater buffers by lenders, reduced liquidity and lower revenue for principals. If there is overwhelming evidence that naked short selling is an issue then the need for regulation is justified. However, is there any evidence other than naked short selling is a minute activity and covered short selling is an important factor in providing efficient and liquid markets?
