As markets were assailed by Lehman Factor contagion last autumn, a number of the world's most sophisticated stock exchanges got queasy and temporarily banned shorting, figuring that while it was okay to speculate that a stock would go up in price, taking the opposite view was heresy and unsporting.

Hong Kong didn't follow suit. Short selling of stocks in Hong Kong, which accounted for 7.5% of market turnover in 2008, was already governed by a tougher set of rules than other exchanges. Under the tick rule, short sellers in Hong Kong can only place orders at or above the lowest ask price, and then wait in line for their order to be executed. (Market makers in stock options and futures aren't bound by this rule.)

After the other exchanges put the kibosh on shorting (and found that volatility wasn't reduced), Hong Kong looked like a paragon of enlightened thinking.

The Securities and Futures Commission has now put its money where its mouth is, and has produced a survey that appears to back up its stance. The survey found that trading volumes increased in Hong Kong as short selling increased, and attributes this to its ability to assist with price discovery.

The study of sample stocks and analysis of the trades undertaken found that over 80% of market-making, short selling orders were placed at best ask-prices or lower and concludes that this contributed to tighter bid-ask spreads.

The SFC study says: "Some financial institutions and company executives," (presumably referring to Lehman's Dick Fuld), "claimed that shares were being driven down artificially by speculators who short sold stocks, and that this in turn added to investor worries and drove stock prices even lower. However, studies have shown that restrictions on short selling provided little support for stock prices."

With this precedent in mind, we can expect that in future periods of financial stress, Hong Kongers shouldn't feel ashamed to be short.

The results of the SFC survey were released around a month after the International Organisation of Securities Commissions' (Iosco) technical committee published a consultation report on the regulation of short selling. The report -- prepared by the taskforce on short selling chaired by Hong Kong SFC chief executive Martin Wheatley -- contains proposed principles designed to help develop a more consistent international approach to the regulation of short selling.

Iosco is recognised as the leading international policy forum for securities regulators. The organisation's membership regulates more than 95% of the world's securities markets and Iosco is the international cooperative forum for securities regulatory agencies. Iosco members regulate more than one hundred jurisdictions and its membership is steadily growing. Members comprise of 100 countries including the US, the EU's 27 member states, Japan and Hong Kong.

Iosco's taskforce on short selling was established by the technical committee in November 2008 in response to concerns regarding the impact that short selling was having in markets worldwide. The taskforce's aim was to work to eliminate gaps between the different regulatory approaches to naked short selling -- whereby a dealer sells shares in a company without borrowing them first -- while minimising any adverse impact on legitimate activities, such as securities lending and hedging, which are critical to capital formation and reducing market volatility.

The report recommends that effective regulation of short selling should be based on four principles: short selling activities should be subject to appropriate controls to reduce or minimise the potential risks that could affect the orderly and efficient functioning and stability of financial markets; short selling should be subject to a reporting regime that provides timely information to the market or to market authorities; short selling should be subject to an effective compliance and enforcement system; and short selling regulation should allow appropriate exceptions for certain types of transactions for efficient market functioning and development.