Locate (Short Selling)
A locate in short selling is a broker-dealer's written or electronic confirmation that shares of a specific security are available to be borrowed before a short sale is executed, as required by SEC Regulation SHO. Without a valid locate, broker-dealers are prohibited from accepting or executing a short sale order, preventing 'naked short selling' where shares are sold short without any assurance that they can be borrowed.
Key takeaways
- Regulation SHO Rule 203(b)(1) requires broker-dealers to have reasonable grounds to believe that the security can be borrowed before accepting a short sale order from a client—the 'locate' requirement.
- A locate is not the same as a confirmed borrow: it indicates that shares are available for borrowing but does not reserve or guarantee them; the actual borrow is typically arranged on the trade date or settlement date.
- Securities on the 'easy-to-borrow' (ETB) list—liquid, large-cap stocks with ample available supply—may have locates granted automatically; 'hard-to-borrow' (HTB) securities require specific approval from the prime broker's securities lending desk.
- Borrow costs vary dramatically: easy-to-borrow securities may cost 0.1–0.5% per annum in lending fees, while highly shorted or illiquid securities ('special' borrows) can cost 10–100%+ per annum.
- Failure to deliver (FTD) violations under Regulation SHO result in mandatory close-out requirements: broker-dealers must purchase or borrow shares to cover positions that fail to deliver for more than the settlement period.
Explanation
The locate requirement was established by the SEC under Regulation SHO (2005) to address the practice of naked short selling, in which sellers short shares without borrowing (or even locating) them first. Naked short selling creates a risk of settlement failure—the seller cannot deliver shares to the buyer—which can undermine market integrity and, in extreme cases, cause supply/demand imbalances in securities. The locate rule creates a gatekeeping function: broker-dealers must affirmatively confirm available supply before allowing short sales to proceed.
The process begins when a hedge fund or other short seller requests a short sale in a particular security. The fund's prime broker (or execution broker for agency orders) must obtain a locate from the securities lending desk before accepting the order. For easy-to-borrow securities—major index constituents, ETFs, and other highly liquid instruments—prime brokers maintain 'pre-approved' ETB lists that allow automatic locate confirmation. For hard-to-borrow securities, the prime broker must contact the securities lending desk, which queries its internal inventory of shares held in customer accounts (with permission to lend) and its network of lending counterparties (other broker-dealers, custodian banks, and institutional lenders). If shares can be sourced at an acceptable borrow rate, the locate is granted.
Borrow cost is the annualized fee paid to the lender of the shares, expressed as a percentage of the loan value. In equilibrium, borrow costs reflect the supply and demand dynamics of the securities lending market: abundant, widely held securities lend cheaply (often at 0.10–0.30% per annum), while scarce, heavily shorted securities command premium rates. During market events that drive a surge in short interest—such as a failed merger, accounting investigation, or meme stock frenzy—borrow costs can spike dramatically. During the GameStop short squeeze in January 2021, borrow costs for GME shares exceeded 100% per annum as demand for borrows far exceeded available supply, and some shorts were involuntarily recalled (their borrowed shares returned by lenders seeking to sell) at the worst possible moment.
Locates are subject to important nuances that practitioners must understand. A locate granted in the morning may not be honored if market conditions change and the stock transitions from easy- to hard-to-borrow. Borrows can be recalled by the lender at any time (typically with one day's notice), forcing the short seller to either find a replacement borrow or cover the position. In addition, there is no guarantee of continuing availability at the current borrow rate: a fund that established a short position at 1% annual borrow cost may find the cost rising to 10%+ if short interest in the stock increases significantly.
The legal distinction between a locate and a confirmed borrow matters for regulatory compliance. Under Reg SHO's close-out provisions (Rule 204), when a short seller's trade results in a failure to deliver (the broker cannot deliver shares by the settlement date), the broker-dealer must close out the position by purchasing or borrowing shares no later than the beginning of regular trading hours on the next settlement date. Repeated failures can result in the security being placed on the Threshold Securities List, triggering enhanced close-out obligations.
Formula
Borrow Cost ($) = Share Price × Shares Borrowed × Borrow Rate × (Days Borrowed / 360)
Example
A long-short equity fund wants to short 100,000 shares of a micro-cap biotech company (daily average volume: 500,000 shares) as a hedge against a long position in a competitor. The fund calls its prime broker to request a locate. The securities lending desk reports that the stock is 'hard to borrow': available inventory is only 80,000 shares at a borrow rate of 45% per annum. The fund accepts the locate for 80,000 shares and arranges to borrow from a second prime broker for the remaining 20,000 shares at 55% per annum. The blended annual borrow cost is approximately 47% per annum, or roughly $12.90 per share per year (on a $100 stock). Over six months, borrow cost alone will represent approximately $6.45 per share—meaning the stock must decline by more than that amount for the short to be profitable after accounting for financing costs, before market impact costs of establishing and covering the position.
Related terms
Borrow Cost Broker Dealer Cap Cover Custodian Easy To Borrow Equity Hard To Borrow Hedge Fund Long Short Equity Market Impact Market Impact Cost