The new presentation gives users valuable information about how hedge funds and other investors participate in the marketplace through short selling. As the presentation describes, short selling generally means borrowing an asset (a security/stock, commodity futures contract, and corporate or sovereign bond) from a broker and selling it, with the understanding that it must later be bought back (hopefully at a lower price) and returned to the broker. The short seller then closes out the short position by buying equivalent securities on the open market, or by using an identical security it already owned, and returning the borrowed security to the lender. As many news stories highlight short selling as a negative force in our markets, the new presentation explains how short selling can be a way for investors to communicate their view on the price of an asset. Short selling also provides many other critical benefits to investors, including: • Risk management for hedging long positions and managing portfolio risk • Increasing efficiency in the marketplace because the transactions inform the market with their evaluation of future stock, bond, or commodity price performance • Lowering overpriced securities by encouraging better price discovery • Providing liquidity by increasing the number of potential sellers in the market Learn more about the global hedge fund industry at: www.hedgefundfundamentals.com.

1. SHORT SELLING
AN IMPORTANT TOOL FOR PRICE DISCOVERY AND
LIQUIDITY IN THE FINANCIAL MARKETPLACE

2. Short Selling
2
Contents
Executive Summary
What Is Short Selling?
Why Do Traders Sell Short
How Does Short Selling Influence
Prices?
Three Common Short Selling
Platforms
How Does Shorting Work In The
Stock Market?
Short Selling In The Commodities
Marketplace
Short Selling And
Sovereign/Corporate Debt
Short Selling Restrictions
Effects Of Short Selling Bans
Short Selling Restrictions
References
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Short selling often receives considerable attention in
the financial media.
Misconceptions have taken root in news reports
leading to coverage that is often critical and
incomplete.
This presentation offers a brief overview of the role
short selling plays in the marketplace, as viewed
through three distinct trading platforms – equities,
commodities, and sovereign debt.
Executive Summary:
Equities/
Stocks
Sovereign
Debt
Commodities

3. What is Short Selling?
3
Short selling can be used:
• To profit from an anticipated downward price movement
and / or
• To hedge the risk of a long position in the same security,
in a related security, or other type of long exposure
Sources: MFA Glossary; http://www.sec.gov/divisions/marketreg/mrfaqregsho1204.htm.
Short selling generally means borrowing an asset (a security /stock, commodity futures
contract, and corporate or sovereign bond) from a broker and selling it, with the understanding
that it must later be bought back (hopefully at a lower price) and returned to the broker. *
The short seller closes out the short position by buying equivalent securities on the open
market, or by using an identical security it already owned, and returning the borrowed security
to the lender.

4. What is Short Selling?
4
Time
Price
Investor exits short position and
makes a profit
Investor believes stock, from
Company X, is overpriced
and takes on „short-position‟*
Over time, Company X‟s stock
value does decline
$15
$30
Price Difference X Number of Shares = Profit
Profit
Short selling is a trading strategy investors use when they believe that shares of a particular
stock, bond or commodity, is overpriced.
$0

5. Why Do Traders Sell Short?
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A. Risk management for hedging long positions and managing portfolio risk
B. Increasing efficiency in the marketplace because their transactions inform the
market with their evaluation of future stock, bond or commodity price performance.
C. Lowering overpriced securities by encouraging better price discovery
D. Providing liquidity by increasing the number of potential sellers in the market*
*Source: http://www.fsa.gov.uk/pubs/discussion/dp09_01.pdf
Some believe short selling is purely driven by profit motive and that it has little or no value in
the broader financial markets.
While the potential for profit can sometimes be an incentive to enter into various trading
positions.
There are many other more critical benefits that short selling provides to investors including:

6. How Does Short Selling Influence Prices?
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Markets function most efficiently when the current trading price of an asset reflects
an accurate estimate of an asset‟s worth.
Short selling is one useful avenue for investors to communicate their view
on the price of an asset.

7. How Does Short Selling Influence Prices?
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If short selling did not exist, prices would predominantly reflect only positive views, driven by
buyers in the market, thus pushing prices higher through their demand.
.
Those artificially inflated prices would not represent the true, efficient trading price of
the asset since they would be created with incomplete information and omitting
negative viewpoints of the asset.

8. Three Common Short Selling Platforms
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Three common platforms where short selling happens:
Investors borrow
shares of a company
with an understanding
that they will have to
be returned at a set
date in time in the
future
Investors express their
short view by buying credit
default swaps to protect
against downward
movement in the price of
sovereign and/or corporate
debt
Investors contract to
sell a commodity at a
later date with the
expectation that the
commodity‟s price will
be lower at that time
Equities / Stocks Commodities Sovereign / Corporate
Debt

9. How Does Shorting Work in the Stock Market?
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There are two main reasons equity investors employ short selling:
• To act on their viewpoint that a particular stock is overpriced / over-valued
• Example – if an investor believed that Company X‟s customer base was shifting
away from them and anticipated lower earnings later that year, he/she could
put on a short sale reflecting the expectation of a decline in share value.
• To provide balance in their portfolio and offset (or hedge) a long investment
position
• Example – An investor holds 100 shares of Technology Company A stock in a
long position. In order to provide balance to his portfolio – and protect against
volatility and risk – the investor could borrow 100 shares of Technology
Company B stock (another company in the same sector) to offset, or hedge, his
long investment position.
The Equities Trade:

10. Short Selling in the Commodities Marketplace
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The most common application of short selling in the commodities marketplace is as a hedge to offset
longer investment positions.
In these trades, fund managers – Commodity Trading Advisors (CTAs) -- use hedges to manage risk
and volatility in the marketplace.
The Commodities Trade:
Sally, a Chief Investment Officer for a corporate
pension plan, is worried about inflation risk.
So, she invests in gold to offset the risk that her portfolio will
decline in value due to inflation.
Inflation Risk?
Gold
Stocks
Bonds
Alternative Investments
Real Estate

11. Short Selling in the Commodities Marketplace
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While there is a popular criticism that short selling impacts the price of a commodity (i.e.
gasoline, orange juice, soy) in the real world, studies have shown that consumer prices
are not directly influenced by short sellers in the marketplace.
An Interagency Task Force on Commodity Markets, which included representatives from
the CFTC, produced a report in that concluded:
“If a group of market participants has systematically driven prices, detailed daily
position data should show that that group’s position changes preceded price
changes. The Task Force’s preliminary analysis, based on the evidence available to
date, suggests that changes in futures market participation by speculators have
not systematically preceded price changes.”*
The Commodities Trade:
Source: Interagency Task Force on Commodity Markets, Interim Report on Crude Oil. Washington D.C., July 2008.
In the U.S., commodities markets are regulated by the Commodity
Futures Trading Commission (CFTC).

12. Short Selling in the Commodities Marketplace
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• Weather events
• Political instability
• Global economic performance
Consumer prices of commodities are most heavily driven by basic factors of
supply and demand and variables such as:

13. Short Selling and Sovereign / Corporate Debt
For decades, governments have sold bonds to investors to help finance immediate infrastructure projects
and to meet their financial needs.
Investors can take long and short investment views on individual countries‟ bond offerings and credit
worthiness, based on their belief that the country will be able to repay the bond in full when it comes due.
A short investment position in a government or corporate bond is taken by purchasing a credit default swap.
This is the way an investor expresses their view that the country or company will not be able to pay the full
value of the bond at maturity, resulting in a lower redemption price.
There are a number of factors that influence how investors view and evaluate individual countries‟ sovereign
debt offerings:
• Political Volatility
• Economic Volatility
• Aging Population
• Economic Growth/GDP
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Short Selling and Sovereign / Corporate Debt:

14. Short Selling Restrictions
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The Regulation of Short Selling:
*Source The effects of short-selling public disclosure regimes on equity markets,“Oliver Wyman, pp. 7.
Investors holding long and short positions are governed by the laws of the individual
country – and marketplace – where they are trading.
Throughout the years, countries have implemented a variety of additional restrictions governing
the practice of short selling.
In the United States short selling is regulated by the Securities and Exchange Commission (SEC).
Many of these restrictions have been temporary in nature, responding to a particular market event
or external factor – for example, U.S. regulators placed a ban on short selling of financial stocks
during the depths of the financial crisis in 2008. The goal of the ban was to prevent further decline
in market value and reduce volatility, but studies have shown the ban did not have the intended
effect.*
The next slide provides more information on the impact of recent short
selling events.

15. Effects of Short Selling Bans
In recent years, regulators have, specifically in the European Union, implemented temporary bans on
short selling activities following certain market fluctuations. Numerous studies analyzed the effects of
these bans on financial markets, finding that bans:
15*”"The effects of short-selling public disclosure regimes on equity markets,“ Oliver Wyman, pp. 7.
=**”Why Banning Short-Selling Doesn‟t Do Any Good.” August 12, 2011. CNBC.com
• Resulted in increased
volatility
• Made capital raising more
difficult for certain issuers
• Reduced market efficiency
• Decreased trading volume
and market liquidity
• Increased bid-ask spreads
Effect of Short Selling Bans:
Conclusion: Short selling bans did not stop steep price declines in the US and UK securities
markets in 2008.

16. Short Selling Restrictions
Currently there are a number of short selling restrictions in place in the E. U.:
On November 1, 2012, the European Short Selling Regulation (SSR) went into effect. Under
the new regulation, European Union Member States will have authority to enact emergency
bans during extreme periods of volatility.
Part disclosure regime, part (naked)* sovereign shorting ban, the European regulations impact
a wide variety of trades and there are signs that the markets are already adjusting.
Generally, the rules ban the shorting of European sovereign debt other than as a hedge.
The rules also require the disclosure of substantial short positions in listed European
companies.*
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*Naked short selling means an investor does not own the securities at the time of the sale and has not made arrangements to borrow them in time to make delivery
to the buyer.”
*Source: Europe’s naked short selling ban leaves investors with skin in the game

17. References
U.S. Regulatory Agencies:
Securities and Exchange Commission (SEC)
www.sec.gov
Commodity Futures Trading Commission (CFTC)
http://www.cftc.gov/
European Resources:
European Securities and Market Authority (ESMA)
www.esma.europa.eu/
Financial Services Authority (UK)
http://www.fsa.gov.uk/
Additional Resources:
International Organization of Securities Commissions
http://www.iosco.org/
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To read more about how federal regulators are handling issues related to short selling please see: