The Capital Game of Short Selling - Glaucus Loses its Credibility

May 08, 2017 15:00 JST

Source: Finet Group Ltd

HONG KONG, May 08, 2017 - (ACN Newswire) - Making money is always the market's game, and the capital markets are a wonderland for investors. Capital markets are different from other markets, as asset partitioning creates numerous smaller assets, each having an asset value that is susceptible to information and control; this is the reason why financial organisations will always take advantage from this quality to make huge profits in the capital markets. Strictly speaking, short-selling research organisations are adding an 'aphrodisiac' to market intelligence that confuses small and medium-size investors.

Notable short-selling research firms in the market include Muddy Waters Research, Glaucus Research, Citron Research, and Anonymous Analytics. These organisations have tentacles with a far reach, and once a company is targeted by a short-selling research organisation, its stock price is destined to plummet without fail when a short-selling report is released. As a result, short-selling research firms are often considered the accomplices of short-sellers.

The Cost of Short-Selling -- The relationship between short-selling research firms and short-sellers

Before we talk about short-selling research organisations, let's start with the term 'short-selling'. What is 'short-selling'? In simple terms, short-selling takes place when an investor predicts the price of a security asset will drop, and without owning the security, the investor borrows the target security from a securities firm or holder at an interest, and sell short; if the price drops as expected, the investor can buy back or 'cover' at a lower price and pay back the interest, thus profiting from the difference.

However, short-selling is not applicable to all securities assets. In Hong Kong's capital market, only securities listed on the Hong Kong Stock Exchange's 'Designated Securities Eligible for Short Selling' are eligible, so for a short-seller, all that needs to be done is review the list to find a target. In fact, both short-sellers and short-selling research organisations live off the business of short-selling, and are not much different in their nature.

In the case of Glaucus Research, it is a professional organisation that specialises in short selling reporting. The logo of the company is a 'blue dragon', which is a small but strong marine creature that looks like a mutated lizard. Back to what's at hand, under its terms of service, it states that users 'agree that use of Glaucus Research California LLC's ("Glaucus") research is at your own risk. In no event will you hold Glaucus or any affiliated party liable for any direct or indirect trading losses caused by any information on this site.'

As a short-seller, there is a cost for every short selling activity in terms of market condition, stock quantity, the reputation of the short-seller and the cost of interest. According to the short selling instructions on a securities firm's website, the interest rate for short selling is agreed by both parties, and it is similar to futures in which the floating margin rate is based on mark-to-market, stock's daily price and changing margin conditions. According to the requirement of the Hong Kong Stock Exchange, investors have to provide a collateral of at least 105% of the value of the stock borrowed, but this number might vary for different securities firms.

Example 1:
- Maintenance margin is 115% of market value
- If Tencent (0700.HK) price rises to $110
- Margin ratio = 114% [125,000 / (110*1000), lower than 115%]
- Since the margin ratio is lower than 115%, margin deposit is required
- Deposit amount= $11,250 [1.25 * (109 * 1000) - 125,000]

Example 2:
- If Tencent price falls to $90
- Margin ratio = 139% [125,000 / (90 * 1000), greater than 115%]
- No margin deposit is needed.

Stock Return:
- You can buy back through Internet or our staff. After that, you must inform CHIEF, otherwise the return process will not be completed;
- The loan fee will be deducted from the short sell account at settlement day (T+2).

Importance:
- Short sell order can only be made when stock borrowing is confirmed by CHIEF;
- The short sell order must be conducted in continuous trading session, and the selling price must not be lower than the ask price;
- If the price keeps rising, the client will bear unlimited floating loss;
- If the dividend payment occurred, the company will deduct the dividend from your account at the Ex-Dividend date.

Charges:
- SBL Registration Fee - $300 (Include $270 First Registration Fee and $30 administration fee)
- Administration Fee - $100 (Given that stock borrowing or lending is executed from January to June / July to December)
- Loan Fee - Differ from stock and subject to minimum charge

Short-sellers are willing to do anything for profit. In the case of Fullshare (0607.HK), the company has actually experienced success in the early phase of its business transformation, with new energy and healthcare sectors making great financial contribution to the company. According to inside sources, Fullshare currently has a net asset value of $30 billion which will increase to $50 billion within the year. In addition, the company's childcare and education division has plans to expand to markets in Australia, Beijing, and Chengdu. So, it is a huge gamble for Glaucus to target a company like Fullshare.

According to inside sources, Glaucus and other short-sellers have borrowed 950 million shares of Fullshare, and have sold 770 million shares at an average selling price of HK$3, meaning they still have 180 million shares (worth $23.1 billion) in hand. If all shares were sold, it would have resulted in income of $28.5 billion. Without taking the cost of borrowing into account, if the price of Fullshare rose to HK$3.5, short-sellers such as Glaucus would have to post an additional HK$4.75 billion in deposit to repurchase the stock in order to return it to the lenders. In addition, if short-sellers decided to sell all shares, they would still have to post the deposit.

Short-sellers face great risk with the possible occurrence of margin calls. If the stock price of Fullshare skyrocketed and surpassed the average selling price of HK$3, short-sellers would face great loss, and have to wait for the price to drop for liquidation. However, to maintain the maintenance margin, they are required to post additional deposits, which continue to increase if the stock price continues to rise. If the maintenance margin is not kept, short-sellers will be forced to liquidate.

The poor quality of short sell Research -- How short-selling organizations Stage the Attack

Short-sellers will form alliances in their quest for gaining profit, and will make extensive preparations ahead of time. There is a network of organisations that stands to profit by association with short-selling research companies such as Muddy Waters Research, Anonymous Analytics, and Glaucus. Before launching every attack, short-sellers make meticulous preparations in terms of capital, share position and research reports, but their focus is always Hong Kong listed companies.

Since its establishment six years ago, Muddy Waters Research has short-sold seven Hong Kong listed companies, and its latest attack was during 16-19 December 2016, when it released two short-selling reports on China Huishan Dairy (6863.HK). Another short-selling research organisation, Citron Research, short-sold development giant China Evergrande Group (3333.HK) on 21 June 2016, and Anonymous Analytics short-sold Rexlot Holdings (0555.HK), Hsin Chong Group (0404.HK), and Credit China (8207.HK).

The effects of these short-selling reports vary, but the targeted company usually suffers a big drop or amplitude on the same day. For example, the price of Evergrande dropped 20% when Citron Research released its report on company, Rexlot Holding 80% with Anonymous Analytics, and Tech Pro 90% in the case of Glaucus.

In fact, short-sellers generally plan their attacks weeks ahead of time instead of waiting until the release day of the report; therefore, they do not simply profit from a one-day plummet but manage to gain a higher earning. Using Glaucus's short-sale of Fullshare as an example, according to inside sources, Glaucus and other short-sellers already had their plan laid on 10 February 2017, but when substantial profits couldn't be made, they published the short-selling report to maximise their profits.

A 10% Probability? The short selling Probability of Glaucus

How do short-selling research organisations choose their targets? They usually select companies that are undergoing business transformation or mergers and acquisition, or have flaws in their finance, all of which make them vulnerable to short-selling. In fact, the success of short-sales relies entirely on probability, and short-selling research organisations might encounter one fail out of ten listed companies. It is just like flipping a coin, there is always a 50% probability that you will get heads, and if you keep guessing heads, you will definitely get it right at least once.

Using the case of Glaucus for another example, this short-seller has short-sold over 20 listed companies since 2011 which include five US-listed companies, ten Hong Kong listed companies and five listed companies from other markets. Glaucus didn't start short-selling Hong Kong listed companies until 2012, and the success rate was 10% among the ten listed companies that were short-sold during the five years.

See image No 1

Is Glaucus working alone? The answer is a definite NO because wolves travel in packs. Looking at the ten listed companies that Glaucus short sold will give us some clues, since short-sellers have to plan ahead before the report is released in order to maximise their profit margins. Based on the charts above, organisations with the maximum fluctuation in position three weeks after the release of the report are Standard Bank, HSBC, JP Morgan, UBS, and CITIBANK N.A.

Among these organisations, Standard Bank and HSBC had the greatest movement in their positions, but of course, these financial organisations might not be using its full position and lend some of it to other organisations, meaning that Glaucus might have association with more investment organisations than indicated in the data. In these ten instances of short selling, short-sellers gained lucrative profits from Tech Pro, which reported a 90% drop within three weeks, and CTEG 40%.

In the cases of Shougang Fushan Resources, Ozner Water, and CTEG, Glaucus decided to further raid these companies. In the first phase, CTEG experienced a 12.62% drop, and when trading was resumed seven days later, another attack was launched. However, Glaucus doesn't win all the time. In the case of Ozner Water, its stock price dropped 20.06% during the first attack, but six months later, its price jumped 14.45% despite a second attack, and rose a further 3.27% five days later when the third attack was launched.

The attack on Fullshare - Proof of Glaucus's low Credibility

Let's use the short sale of Fullshare by Glaucus as an example. When the short-selling report on Fullshare was released on 25 April 2017, Fullshare filed for an immediate suspension. With this example, we can pretty much reconstruct the short selling process of short-sellers.

See image No 2

From a relevant site, we can see the position for Fullshare changes for various investment organisations. During the three-week interval after the release of the report, the position of UBS fluctuated the most at 1.10431 billion shares, and BNP Paribas came second at 397 million shares.

According to the short selling process, short-sellers will wait for the stock price to drop to a level that yields a satisfactory profit margin, then buys it to give back to the borrower, meaning that UBS likely acted as a borrowing institution, but we cannot rule out the possibility that other short-sellers borrowed its position.

See image No 3

According to data from 25 April 2017, 1.52154 billion shares were reduced from HSBC's position which accounted for 7.7% of total shares issued, and 417.23 million shares more than UBS's position. These data can either be seen as proof of the activities of short-sellers or ordinary transactions. Comparing the position change of UBS and HSBC, we can deduce that UBS has already made a profit from short selling but not HSBC.

If this insider data is accurate, short-sellers made a total profit of HK$950 million before the suspension of Fullshare. With a 5x leverage ratio and 10% financing cost, the net profit is at least HK$722 million. If Glaucus was to receive a percentage, it would amount to HK$72.2 million at 10%, making it even more profitable than robbing a bank!

In summary, short selling research organisations attacked listed companies to make money, and their success relies entirely on a probability that has no foundation. In the case of Glaucus, only one of the ten listed companies was delisted, that is a very low ratio to even establish any credibility. Since various evidences indicate that short selling reports are created with a specific purpose to rip off companies, and small and medium investors, short selling research organisations have a low credibility and should not be trusted.

Finally, investors should see Fullshare's retaliation as a bold step in beating back the malicious acts of short-sellers!

(C) Finet Market News, 2017. http://bit.ly/2qgaDnY

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Source: Finet Group Ltd
Sectors: Exchanges & Software, Daily Finance