17/08/2011 Author: Tony Griffiths

Short sighted

In response to the recent stock market upset, four Eurozone countries have implemented a fresh ban on short-selling, bringing to mind the dark days of 2008. But many in the hedge fund industry contend that such measures are unlikely to have the desired effect on recovery.

Following a full week of jagged market volatility around the globe, last Thursday night France, Italy, Spain and Belgium each implemented 15-day bans on the shorting of financial shares. The hedge fund community groaned. The markets responded by slipping yet further in Friday morning trading.

The effectiveness of short-selling bans has been the focus of much debate over the past three years, since a number of international regulators – the US and the UK among them – introduced such temporary measures during the onset of the 2008 credit crisis. Reports and studies from a number of bodies – including the Committee of European Securities Regulators (Cesr), the predecessor to current EU market super-regulator Esma – have declared short-selling an important market tool, and the EU was expected to temper its approach when putting the final touches to new short-selling legislation due later this year.    

“The EU has an initiative in place to try and introduce a harmonised regime across the EU, but here we are, nearly three years on from 2008, and we’re still coming into work trying to track down which countries have brought in bans, which bans are different and which are similar,” says Peter Moore, head of regulation and compliance at IMS Group.  
“Do I think it’s a knee-jerk reaction? Yes. Do I think it will help? No. The sober academic analysis of short-selling seemed to continually say that these bans don’t do what people think they do. I would go further and say that they actually do the opposite.”

Moore isn’t the only one. In a statement revealing “regret” at the quartet’s move, Andrew Baker, CEO of global trade body the Alterative Investment Management Association (Aima), was quick to suggest that “past experience has shown that bans on short-selling do not prevent market falls and indeed can exacerbate volatility.” Kinetic Partners’ Andrew Shrimpton said that the measures “will only reduce price volatility for a few days at best”.

Much frustration has derived from what appears to be a lack of progress in the understanding of short-selling. Cesr’s findings last year were that “legitimate short-selling plays an important role in financial markets… and can possibly help mitigate market bubbles”. That EU member states should respond in the manner they have has been a matter of much confusion. The phrase ‘closing the stable door after the horse has bolted’ has been bandied around by more than one commentator.

“We’ve been here before with regards to short-selling rules and, even though I have some sympathy for the superficial reason why it has been done, all the evidence suggests that prices of the now restricted stocks fall further and market quality deteriorates, market volatility increases, liquidity declines, bid offer spreads widen, and market debt shallows,” says Doug Shaw, managing director at BlackRock.

“Plus, the new restrictions are inconsistently worded across the four countries, take time to read and by the time they do it you’re less interested in their markets anyway.”

Added uncertainty is also a problem. Shaw reveals that on Friday he heard reports that some banks were not taking orders from all clients in euro stocks, for fear that benign new short positions in highly liquid euro stock futures might fall foul of the new restrictions. Additionally, one bank is reportedly offering out its inventory for shorting via derivatives, a practice that is, for Shaw, “outside the spirit of the new restrictions” as he understands them. “I’m left with some short positions in the restricted stocks and an opportunity cost in as much as freedom of movement is restricted,” he says.    

The uncertainty also extends to the bans themselves. “We could see a lifting of the ban in 15 days but that would require the market volatility to cease and the shorting-selling ban isn’t going to achieve that,” says Moore.
Moore suggests that the likes of Germany and Portugal could follow in implement bans. The FSA was quick to deny it was considering such measures in the UK.

A source close to discussions among leading EU nations believes that if any others were going to do so, they would have done so by last Friday. A conference call took place late Thursday night with the 27 national regulators represented by Esma, which resulted in the bans. “France and Italy tried to get greater support, but only succeeded in getting Spain and Belgium onboard,” the source reveals.     

The final issue is one of legacy. The EU’s new short-selling legislation was due to be finalised in July, but has been pushed back until after the summer recess. While not as divisive as recent, more infamous, fund legislation, it has spawned polarised positions. It remains to be seen the extent to which Thursday’s bans offer fresh impetus to either side of the argument.