SFC Securities Lending Regulation: Reporting and Disclosure for Covered Short Selling

The Hong Kong Securities and Futures Commission (SFC) has sharpened its focus on securities lending and short selling activities in 2025. The catalyst was a series of enforcement actions taken against several licensed corporations for failures in their stock borrowing and reporting procedures. These cases, which came to light in late 2024 and early 2025, revealed systemic weaknesses in how firms track borrowed stock and report short positions to the Exchange. The SFC’s 2024-2025 Enforcement Report, published in March 2025, explicitly identifies “inadequate controls over securities lending and short selling” as a priority area for the coming year. For compliance officers and licensed corporations, the message is clear: the era of treating securities lending as a low-compliance back-office function is over. The regulatory framework under the Securities and Futures Ordinance (Cap. 571) and the HKEX Rules now demands rigorous, real-time reporting and transparent disclosure. This article provides a structured guide to the current regulatory requirements for covered short selling, focusing on the reporting obligations, the disclosure regime, and the practical steps firms must take to remain compliant.

The Regulatory Framework for Covered Short Selling

The legal basis for regulating short selling in Hong Kong is found in the Securities and Futures Ordinance (Cap. 571) and the Rules of the Exchange. The SFC, through its Codes and Guidelines, sets the conduct standards, while the HKEX administers the reporting and disclosure systems on a day-to-day basis.

Defining “Covered” Short Selling

A short sale is “covered” only when the seller has a presently exercisable and unconditional right to vest the securities in the purchaser at the time of the sale. This is the core requirement under the SFC’s Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (the “Code of Conduct”). The Code of Conduct, specifically paragraph 5.1, states that a licensed person must not sell securities unless he has, or reasonably believes he has, a presently exercisable and unconditional right to vest the securities in the purchaser. For a short sale, this means the seller must have borrowed the stock or have a binding agreement to borrow it before the sale is executed.

The legislation provides that a “covered” short sale is not prohibited, provided the seller complies with the reporting and disclosure requirements. An “uncovered” or “naked” short sale is prohibited under section 170 of the SFO. The distinction is critical: a covered short sale requires a pre-existing borrowing arrangement, while a naked short sale does not and is illegal.

The Stock Borrowing Agreement

A stock borrowing agreement must be in place before the short sale order is placed. This agreement can be a master securities lending agreement (such as the GMSLA) or a bespoke bilateral agreement. The key requirement is that the agreement must give the borrower a “presently exercisable and unconditional right” to the securities. This means the agreement cannot be contingent on future events, such as the lender’s ability to deliver the stock at a later date.

The HKEX’s Guidance Note on Short Selling (January 2024) clarifies that a “binding agreement to borrow” must be evidenced by a written contract or electronic record. Oral agreements are not sufficient. The guidance also states that the borrower must be able to demonstrate, upon request by the Exchange or the SFC, that the borrowing arrangement was in place at the time of the short sale.

Reporting Obligations: The HKEX Short Position Reporting Regime

The HKEX operates a mandatory short position reporting regime under the Rules of the Exchange. This regime requires licensed corporations to report their aggregate short positions in specified securities on a daily basis.

Step 1: Determining Reportable Securities

The first step is to identify which securities are subject to the reporting requirement. The HKEX maintains a list of “Designated Securities” for short selling reporting. This list includes all equity securities that are eligible for short selling, as well as certain exchange-traded funds (ETFs) and structured products. The list is updated periodically and published on the HKEX website.

A licensed corporation must report its short position in a Designated Security if the position, at the close of business on any trading day, exceeds HK$10 million or 0.02% of the total issued shares of that security, whichever is lower. This threshold is set out in the HKEX Rules, specifically Rule 723. The reporting obligation applies to the aggregate short position of the licensed corporation, including positions held across all its trading accounts and those of its affiliates.

Step 2: The Daily Reporting Process

The reporting must be submitted to the HKEX via the Short Position Reporting System (SPRS) by 6:00 p.m. on the next trading day after the position is incurred. The report must include the following information for each Designated Security:

• The name and stock code of the security.
• The total number of shares sold short.
• The date on which the short position was incurred.
• The licensed corporation’s participant ID.

The SFC’s 2024-2025 Enforcement Report highlighted that late or inaccurate filings are a common compliance failure. In one case, a licensed corporation was fined HK$3.5 million for failing to report its short positions for 14 consecutive trading days. The SFC’s position is that the obligation to report is absolute and cannot be delegated to a third party without the licensed corporation retaining full responsibility.

Step 3: Record-Keeping Requirements

Licensed corporations must maintain records of all short selling transactions for at least seven years. This includes the stock borrowing agreement, the trade confirmation, and the reporting submission. The SFC can request these records at any time without prior notice. The record-keeping requirement is set out in the SFO, section 130, which requires licensed corporations to keep records that are sufficient to explain the transactions and to enable the SFC to determine whether the corporation has complied with the law.

Disclosure Obligations: Transparency in the Market

Beyond the reporting regime, there are disclosure obligations that apply to short selling activities. These obligations are designed to ensure that the market is informed about the level of short selling in specific securities.

The Stock Exchange Filing Requirement

When a person acquires a short position in a listed corporation that exceeds 0.02% of the total issued shares, that person must disclose the position to the Exchange. This requirement applies to any person, not just licensed corporations. The disclosure must be made within three trading days and must include the number of shares sold short and the date on which the position was acquired.

The legal basis for this requirement is the SFO, Part XV, which governs disclosure of interests. The SFC’s Guidance on Disclosure of Short Positions (February 2023) provides detailed instructions on how to calculate the threshold and when the disclosure obligation is triggered. The guidance states that the obligation applies to both direct and indirect short positions, including those held through derivatives or contracts for difference.

The Annual Report Disclosure

Listed corporations are required to disclose in their annual reports the aggregate short positions in their shares that have been reported to the Exchange during the financial year. This requirement is set out in the HKEX Listing Rules, specifically Rule 13.25. The disclosure must include the total number of shares sold short, the total value of the short positions, and the percentage of the issued share capital that has been sold short.

This annual disclosure is a transparency measure that allows shareholders to assess the level of short selling in the company’s shares. It also serves as a check on the accuracy of the daily reporting by licensed corporations, as the Exchange can compare the aggregate reported positions with the company’s own disclosure.

Practical Compliance Steps for Licensed Corporations

Compliance with the short selling regulations requires a systematic approach. The following steps are based on the SFC’s enforcement actions and the HKEX’s guidance.

Step 1: Implement a Pre-Trade Borrowing Check

Before any short sale order is executed, the trading system must verify that a valid stock borrowing agreement is in place. This check should be automated and integrated into the order management system. The system should also verify that the borrowed stock is not subject to any restrictions, such as a lock-up agreement or a prohibition on lending.

Step 2: Establish a Daily Reporting Workflow

A dedicated compliance team should be responsible for preparing and submitting the short position report to the HKEX by the 6:00 p.m. deadline. The workflow should include a reconciliation step to ensure that the reported position matches the actual short position in the firm’s books. The SFC’s 2024-2025 Enforcement Report noted that reconciliation failures were a common cause of reporting errors.

Step 3: Conduct Periodic Audits

Internal audits should be conducted at least quarterly to test the effectiveness of the compliance controls. The audit should review a sample of short sale transactions to verify that the borrowing agreement was in place before the trade, that the reporting was accurate and timely, and that the record-keeping requirements were met. Any deficiencies should be remediated immediately.

Step 4: Train Trading and Compliance Staff

All staff involved in short selling activities must receive training on the regulatory requirements. The training should cover the definition of a covered short sale, the reporting thresholds, the disclosure obligations, and the consequences of non-compliance. The SFC requires that licensed corporations have a written compliance manual that includes these procedures.

Key Takeaways

1. A covered short sale requires a pre-existing, written stock borrowing agreement that gives the seller a presently exercisable and unconditional right to the securities at the time of sale.
2. Licensed corporations must report aggregate short positions in Designated Securities to the HKEX by 6:00 p.m. on the next trading day if the position exceeds HK$10 million or 0.02% of issued shares.
3. The SFC’s 2024-2025 enforcement priority is inadequate controls over securities lending, with fines of up to HK$3.5 million imposed for reporting failures in the past year.
4. Any person acquiring a short position exceeding 0.02% of a listed company’s shares must disclose that position to the Exchange within three trading days.
5. Record-keeping for all short selling transactions must be maintained for seven years, and the SFC can request these records at any time without prior notice.

This does not constitute legal advice. Consult a solicitor for your specific case.