Watchdog defends short-selling rules

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The Financial Services Authority introduced the rules last month, in a surprise move aimed at restoring confidence ahead of rights issues by mortgage banks HBOS and Bradford & Bingley, after both fundraisings risked failure following steep falls in their shares.

The decision, which means short positions over 0.25 percent must be disclosed, has been criticised by the hedge fund industry, which has queried the need to introduce the measures without qualification, and by some investors.

FSA Chief Executive Hector Sants, however, said the watchdog's unusual decision to push ahead with new rules without consulting the industry had aimed to ensure the issues were "conducted in an open and transparent manner" and had been a success.

"We had a view...that there was abusive behaviour taking place. I am confident that the actions we took led to an abatement in that behaviour," he told reporters after the regulator's annual general meeting.

"I believe the action was wholly justified and the subsequent market developments demonstrate that."

Both HBOS and B&B had shares trading below the rights issue price when the cash calls went ahead but succeeded in raising funds thanks to underwriting and sub-underwriting agreements.

The FSA is currently reviewing the short-selling rules as part of a broader appraisal of rights issues due to be completed later this year, together with the government.

Short sellers, often hedge funds, sell borrowed shares in the market in the hope of buying them back more cheaply at a later date. During a rights period, trading is more volatile and losses accelerate if shares fall below the issue price.

Though a legitimate strategy, short selling has come in for criticism in the past months. U.S. regulators came under pressure to introduce rules after the demise of investment bank Bear Stearns in March and have since limited certain types of short selling in major banks and financial firms.

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