AIM Market Makers, Short Selling and Placings

1 August 2018

There was talk on Twitter yesterday about Matt Lofgran, Chief Executive Officer of Nostra Terra (NTOG), speaking during an interview about a market maker contacting the company, hoping to acquire stock in a discounted placing, allowing them to balance their books against a short position.

This is the first time I have ever heard a CEO speak about this openly and on record. I was very pleased to listen. I hold no shares in the company but will aim to do some research over the coming weeks as the honesty of directors combined with their understanding of how AIM works is something that is important to me.

Of course, to give a balanced view, as you always need to consider all angles of unknown information, it is also possible that this is a new attempt by a CEO of an AIM company to push their shares higher. That said the concept of market makers short selling and participating in placings is one that does warrant a discussion as it happens frequently.

Market Makers

Private investors love to moan about market makers but without them liquidity would be non-existent. The SETS system used by larger stocks just would not work on AIM as with some exceptions the liquidity on many stocks is not present to allow the direct matching of buyers and sellers.

With that said I do think that with a few tweaks to what is allowed would make the market much better and go some of the way to making AIM more weighted towards private investors without which there would also be no market.

Two of the most significant changes that I think would benefit the AIM market are imposing a maximum allowed MM short position (it's currently 10% before disclosure) and not allowing participation in placings.

Short Selling

The argument for allowing a market maker to be short on a stock is that they are duty bound to make a market and with a fast-moving stock they will often have an in balance. They are not confined by the usual FCA 0.5% disclosure as it is an activity that is normal within their role as opposed to an investor looking to take a short position against a particular stock.

However, if the maximum short position was reduced or perhaps more realistically limited to say a few hours or days it would have a massive knock on to the true price of shares trading on AIM. Currently there is little to stop a market maker selling stock to private investors with a disproportionate advantage to the investor on the basis that the stock will be acquired in due course.

I have previously done well from investing in companies where it is obvious that the market is short of stock and when you are able to find a "short squeeze" it does offer a good opportunity, but without some tweaks to the system the opportunity is nowhere near as good as it could be and it's another example of the system being stacked against the investors.

You can also argue that a market maker should hold stock, therefore not justifying being short on a regular basis and if they are not happy to hold a small quantity in exchange for their spread often around 10% then they should not make a market in that stock which may help to drive some of the junk companies away from AIM at the same time!

Discounted Placings

Very much linked to the short selling issue is the participation of market makers in equity fund raisings. I am not sure if the blame here should be with the brokers or the actual companies but suspect it is more the brokers. I have written before that a good broker should be able to seek a longer-term home for a stock and in fact I have taken part in two placings in the last week where the price has not dipped below the placing price (Europae Metals: EUZ and Greatland Gold: GGP). I believe that is partly down to a sensible book being built for each with a number of potential longer-term shareholders.

I would like to see the ability for market makers to take part in a placing stopped as I see no genuine reason why they are allowed to take part. Before this week, when Matt Lofgran from Nostra Terra (NTOG) spoke about the issue, I have seen more than a handful of placings where market makers have taken stock only to flip it in the same way that some private investors look to flip placing stock. However, looking at this from an existing shareholders perspective and also the companies I can't see how you can justify that involving someone with a days or weeks timeframe is anyway good.

A good broker should be able to place stock with investors and that should be a sign of what the stock is worth. Placing stock with a market maker to simply allow them to close an outstanding short position (which will often be hundreds of thousands of pounds) at a discount to the prevailing market price is insanity and just gives a double win to the market makers. Again very much at the expense of the private investor.

Conclusion

Often compared to a casino AIM is my favourite stock market by far. I am an entrepreneur as well as an investor and I enjoy looking for companies that offer significant growth potential, but I also enjoy reading about interesting ideas and quality people. The latter being quite difficult to find within many AIM companies!

However, at times I am concerned about the practices that take place between the various different market participants and I believe the rules for short selling by market makers need to be looked at and more importantly they should also be stopped from taking part in any equity placing.

I am pretty sure that the regulators are fully aware of this, alongside all the other slightly dubious practices, and perhaps one day something will be done about it. Until then investors just need to understand this side of AIM as understanding the market is as important as researching individual companies.