The City’s chief regulator came under heavy fire yesterday as it announced uncompromising new rules to protect companies from investors betting against them when they are raising emergency funds.

Fund managers, lawyers and trade bodies queued up to berate the Financial Services Authority (FSA) for failing to consult them before publishing the new rules, which mean investors betting that company share prices will fall must declare their hands.

From next Friday, any investor who has a substantial short position, equivalent to 0.25 per cent of the share capital of any company involved in a rights issue, will have to have it made public via the Stock Exchange. The FSA added that it was considering tightening the rules governing stock lending to make it harder to bet that a share price will fall.

Critics accused the regulator of enacting policy on the hoof in response to fears that a £4 billion rights issue by HBOS, the mortgage bank that owns Halifax, might fail. One chief executive at a big fund management house that operates hedge funds as well as traditional investment strategies said: “The FSA is clearly prepared to do whatever it takes to make sure that HBOS and its rights issue do not fall over.”

Heavy selling, including by hedge funds, forced HBOS’s shares below 275p, the price at which the rights will be offered, earlier this week. This raised the prospect that a large part of the issue could be left with the underwriters. Yesterday’s move by the FSA had a dramatic effect on a number of stocks that have been under pressure. HBOS shares jumped 14 per cent to 321.75p.

Andrew Baker, deputy chief executive of the Alternative Investment Management Association, the lobby group for hedge funds, said the FSA should have consulted him and his membership. He said the measure set an awkward precedent. He added: “My biggest area of concern is the precedent it sets for the future. There has been no consultation and my members have virtually no time to respond. This appears to be about recapitalising the banking system.”

Mainstream investors welcomed the FSA’s tough action but Guy Sears, director of wholesale at the Investment Management Association, said: “It will no doubt surprise many that the FSA has changed the rules at such short notice and it will cause operational headaches in the short term; but that is a price that a few short-sellers, and not the FSA, have forced upon the market in these exceptional times.” The Association of British Insurers, the investor lobby group, said it welcomed the measure but added that the FSA needed to ensure it was effective.

The FSA introduced its new rules after aggressive short-sellers, who sell borrowed shares into the market in the hope of buying them back more cheaply at a later date, targeted shares in several rights issuers, including HBOS.

At the same time, the FSA embarked on a review of the rights issue process, where companies try to raise fresh funds from existing investors by offering them new shares at big discounts.

As it announced the new rules the FSA said it was responding to an unacceptable level of potential abuse. “The FSA views short-selling as a legitimate technique, which assists liquidity and is not in itself abusive. But it is also the case that the rights issue process provides greater scope for what might amount to market abuse, particularly in current conditions,” the regulator said.

Simon Morris, a partner at CMS Cameron McKenna, a City law firm, said: “This is full of contradictions. The FSA says it is responding to market conditions but these conditions began six, eight or ten months ago. The FSA already has tried and tested rules to protect against manipulation — the market abuse system. The FSA is working against the grain of the market. It is the equivalent of telling hedge fund managers and other investment managers to play their hand in a game of poker with the cards face-up.”

The FSA said that it had consulted industry participants on Thursday, before the release of the new measures, although it acknowledged that no formal consultation process had taken place.

Shares reprieved

The big winners from the FSA's clampdown on short-selling

HBOS up 14 per cent at 321.75

Johnston Press up 20 per cent at 69.75

Alliance & Leicester up 11 per cent at 338.75

Taylor Wimpey up 16 per cent at 70.5

Redrow up 16 per cent at 163.75

DSG International up 16 per cent at 54

Barratt Developments up 13 per cent at 86.5

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive