Oct. 29, 2022
October 29, 2022 The Proposal as currently crafted has a huge hole that must be remedied, one that the Commission is well aware of - an investor wishing to profit from the decline of a securitys value can also trade in various derivative contracts, including options and security-based swaps.8 The failure to include derivative exposure in this rule will inevitably result in firms exploiting the loophole and will drive more and more firms into the less regulated and less transparent space of derivatives. As the Commission acknowledges in the proposal, trading in derivatives frequently leads to related trading in the stock market as derivatives counterparties seek to hedge their risk.9 Derivatives have an impact on the market, and can have a detrimental effect on the price of stocks, as Archegos demonstrated so clearly. While the positions held by Archegos were not disclosed anywhere publicly because they had exploited a loophole in 13F disclosures, the impact on the market was material and overwhelmin g. Indeed, had these derivative positions been adequately disclosed, it is likely that institutional broker-dealers would have had enough information to mitigate the impact of Archegos trading, would have been able to recognize the significant exposure that resulted from the leverage they extended via total return swaps, and would have prevented the crisis from developing in the first place. In much the same way, it is critical for institutional broker-dealers and for retail and institutional investors to understand the extent to which individual firms have high levels of short exposure to individual stocks or ETFs, regardless of whether that exposure is via equity, through the use of derivatives or through other novel mechanisms that the Commission has not considered. Markets are changing and evolving, and as regulators impose new disclosure requirements on firms, those firms will figure out ways to game or avoid those disclosures. Thats what Archegos did with swaps, and thats what other firms might do with other novel ways of gaining short exposure. One example of this could be through security tokens on crypto exchanges. Another could be through the use of fungible or nearly fungible holdings in foreign affiliates - both equity and derivatives.