Covered Short Selling

Covered means the delivery obligation is already solved at the moment of sale. Before the order goes to market the seller has a securities lending arrangement in place, or another presently exercisable and unconditional right to vest the products in the buyer. The broker confirms this as a locate. When settlement falls due the borrowed shares are delivered, and the buyer is never exposed to the possibility that the seller simply cannot produce stock.

Australian law makes this the only lawful route. Section 1020B of the Corporations Act 2001 prohibits selling section 1020B products — shares, debentures and similar financial products traded on a licensed market — without that right to vest. ASIC Regulatory Guide 196 sets out how the prohibition and the accompanying disclosure obligations operate in practice. The framework was tightened after the 2008 global financial crisis, when short selling was briefly banned outright and then reintroduced under the current covered-only regime.

Two separate disclosures follow a covered short sale. The seller must inform its broker that the order is a short sale, and the broker reports that to the ASX as short sale transaction information under section 1020AC, producing the daily gross short sale volume figures. Separately, under section 1020AB, the seller reports its net short position to ASIC once the position exceeds $100,000 or 0.01% of issued capital. The second of those is the dataset behind the short interest percentages on this site.

Because the stock must be borrowed first, every covered short carries the economics of the loan. A borrow fee accrues daily, dividends paid during the loan must be manufactured back to the lender, and the lender retains the right to recall the shares. Those costs are what make crowded shorts in illiquid, hard-to-borrow names expensive to hold, quite apart from the price risk.

The distinction also explains a quirk of the published data. Because positions must be covered, the reported short interest is bounded by the stock actually available to borrow. Figures well above the lendable float would suggest a data or classification problem rather than aggressive positioning.