When Japan’s Government Pension Investment Fund (GPIF) announced the suspension of lending foreign shares this past week, people who dislike short selling rejoiced.
None more so than Elon Musk, which is not hard to imagine; Tesla has been the target of short sellers for almost as long as it’s been public, and Musk has waged bitter Twitter wars against them.
Bravo, right thing to do! Short selling should be illegal.
— Elon Musk (@elonmusk) December 3, 2019
But the GPIF’s move isn’t likely to make that much of an impact – certainly not the kind that Tesla’s chief exec might be hoping for.
Playing It Safe
The premise of the GPIF’s decision seems based more towards enabling a move towards ESG (Environmental, Social, and Governance) principles and less on valid concerns about short selling and its impact on stock prices.
The GPIF has justified its decision via two main points:
- The ownership transfer of lent shares create a “gap” in the period the GPIF holds the stock, which implies the GPIF is not being a good steward of the stock
- There is no transparency in terms of who ultimately borrows the stock and for what purpose
Both are valid points, although they raise questions. On the first point, Travis Lundy notes that, according to Japan’s Corporate Governance Code and Japanese law, the practice of lending stocks does not result in loss of ownership.
Brian Freitas adds that “prudent lenders will not lend more than half their position so they do not have to recall borrowers in case they need to sell some of their stock,” or there’s an important issue they need to vote on.
Read Travis Lundy’s full Insight: GPIF World’s Largest Fund To Suspend Global Stock Lending
The second point is “a valid argument and more difficult to solve for,” Freitas writes. According to him, it’s not so much about who borrows stock as much as the ultimate purpose of borrowing.
“Stock lending should be permitted as long as the external managers conduct their stock lending activity in compliance with tax laws, do not explicitly lend stock to borrowers to arbitrage dividend tax laws (especially not with a view to share the profits of the enterprise), or to borrowers who are looking to borrow shares solely for voting rights,” he concludes.
Lundy notes that most markets do not require reporting of trades under a certain threshold anyway. “Furthermore, the GPIF clearly does not want to advertise what it will do before it does it or as it does it,” he writes. “It would seem odd that the GPIF requires the transparency of intent of other people in the market while not showing transparency of its own intent.”
Read Brian Freitas’s full Insight: Elon Musk Has a New Friend in the GPIF
GPIF CIO Hiro Mizuno has strived to establish himself as a proponent and implementer of ESG principles. This creates a risk that observers will interpret the GPIF’s current stance as indicating that short selling is not compliant with ESG tenets.
As risky as that is, Freitas doesn’t think that’s likely. “Most large asset managers recognise the importance of short selling to promote efficient capital markets and of generating returns for the portfolio,” he writes.
And anyway, Lundy doesn’t think this is what the GPIF is going for. “It would likely be impossible to show empirically that a lack of short selling increases the ability of company management to manage their company appropriately, and increases overall returns,” he points out.
One point of caution is what happens to shares the GPIF has already lent out. Freitas estimates that the fund has lent out around US$20 billion of stock from its portfolio, of which US$5-7 billion is in emerging markets. “If this stock is recalled, there could be some big moves in smaller stocks. If this stock is not recalled, there will be minimal impact of the suspension,” he says.
Freitas believes the GPIF will likely reverse this decision eventually. Lundy, meanwhile, doesn’t think other global pension funds will take a similar route, “though some influence cannot be ruled out.”
Lead image by Aleksandar Pasaric from Pexels