France, Italy, Belgium and Spain have implemented two-week bans on short selling following various restrictions on the practice imposed in Greece, Turkey and Korea in the past week in response to tumbling markets around the world.
Regulators in the UK, Netherlands and Austria are reportedly speaking out against the bans and say they have no plans to limit the practice. Meanwhile, regulators in Germany have called for an EU-wide ban on “naked” short selling.
France, Italy, Belgium and Spain say market speculation and rumor mongering has led to a dramatic decline in stock prices. It has been particularly deleterious in France, where questions as to the creditworthiness of several French banks have led to a disastrous plunge in their share prices. Societe Generale was hit particularly hard, plunging about 15% Wednesday and another 8% Thursday, although it is slowly recovering.
ESMA, the European Securities and Markets Authority, suggested Friday that short selling can be clearly abusive when used in combination with spreading false market rumors. The bans in the four European countries late Thursday were aligned as far as possible in the absence of a common EU legal framework in the area of short selling and given the very different national legal bases on which such measures can be taken, ESMA said in a statement.
But a number of organizations have denounced the moves as worsening the problem of the recent market volatility rather than protecting the markets from it.
We do not think these bans will help the current market situation, says Andrew Baker, CEO of the Alternative Investment Management Association (AIMA). Past experience has shown that bans on short selling do not prevent market falls and indeed can exacerbate volatility. Independent academic research also supports this conclusion.
Baker points to a Committee of European Securities Regulators report, published in 2010, that read: Legitimate short selling plays an important role in financial markets. It contributes to efficient price discovery, increases market liquidity, facilitates hedging and other risk management activities and can possibly help mitigate market bubbles.
Short selling is essential to the proper functioning of the markets, most experts and industry bodies agree.
Short-selling is a legitimate market practice which helps capital markets function effectively, Baker says. Of course market abuse is illegal and has always been condemned by our industry. If there is any proof of market abuse having taken place then the authorities should take appropriate action against the perpetrators. If there is any suggestion of market abuse, however, then it may be appropriate to take more targeted action rather than impose blanket bans of this sort.
The latest restrictions resemble the moves by market regulators worldwide in 2008 to impose various restrictions on short selling, from banning naked short selling to restricting the practice to particular stocks to banning short selling all together.
EDHEC-Risk Institute, the financial research group, went so far as to say it condemns the latest bans by France, Italy, Belgium and Spain.
These hasty decisions are not only devoid of theoretical basis, but also fly in the face of empirical evidence, the EDHEC-Risk Institute said in a statement. Academic studies, including work by EDHEC-Risk Institute researchers, have documented the positive contribution of short-sellers to market efficiency and shown that constraining short sales significantly reduces market quality by reducing liquidity and increasing volatility and can have unintended spillover effects.
The institute says it denounces the decisions to impose or extend short-selling bans as a political smokescreen that is likely to be counterproductive, both directly by disrupting market functioning and degrading market quality at a most testing time, and indirectly by further fuelling defiance vis–vis sovereign states and the continued inability of their political institutions to address the causes of the current crisis.
In defense of short selling, Bob Sloan, author of the book Dont Blame the Shorts: Why Short Sellers Are Always Blamed for Market Crashes and How History Is Repeating Itself, told GCs Dominic Hobson in the Spring 2010 issue of Global Custodian magazine: A true democracy values dissent, and it also protects the minority, and it does so because it understands, Dominic, as you rightly said, that it’s fundamental values; it’s who you are; it’s part of the culture; it’s part of the reason why we have the civil liberties that we do. Shorting in the financial sense is that voice of dissent. It is that minority that needs to be protected. The reason why the Anglo-Saxon world has the best capital markets is because they have the best information. The reason we have the best information is because we have checks and balances. And so when you start distorting that checks and balances, it’s absolutely at odds with the transparency that most administrations say they want.
(CG)