To Net or Not to Net, That Is the Question

Sustainable finance regulation has largely overlooked alternatives, particularly hedge funds, given the greater complexity of strategies and asset classes. However, regulators are now expanding their scope to recognise the role that hedge funds can play in sustainable finance. The role of short selling in sustainable finance, especially in a net zero context, has been increasingly discussed and debated among regulators, market participants, investor initiatives, investor trade organisations and ESG data providers. There is a concern that hedge funds may intentionally or unintentionally employ short selling to misrepresent their real-world impact which is distinct from exposure to financial risk. This article summarises these arguments and traces the signals from UK, US and European regulators. It contributes to the discourse by providing considerations to the channels of influence, specifically the efficacy of short selling among different asset classes to affect the cost of capital; the time-varying aspect of short selling; and the limitations that short sellers face when engaging corporates. Last, the EU – as the regulator with the most mature regulatory framework – appears to establish a compromise that balances safeguards against greenwashing with the mechanics of portfolio management and reporting.

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