Short-Selling Bans ‘Causing Chaos’

September 23, 2008Andy No Comments »

Australia, Britain was the first to ban investors from taking short positions on banking and financial institutions’ shares last week and was followed on Friday by bans in the US sharemarkets.

The Australian stock exchange (ASX) took it one step further on Monday banning short selling across the entire market. Its introduction saw a one hour delay of the market opening as clarification was sought over who would be affected. ASIC contends that it couldn’t stand alone once the US and Britain banned shorting of financial stocks, and were followed by other countries, and that’s undoubtedly the case. It may, however, have been overkill to widen the ban from financial stocks to all listed stocks.

The bans have been introduced to stop investors from shorting shares and driving share prices to the point of collapse. The finger has been pointed in particular at some US hedge fund managers who are said to have purposely driven down the price of shares using “naked” shorting in companies like the now bankrupt Lehman Brothers in order to make a profit.

Britain had been clear about including CFDs in its ban but other countries had not made it so simple. A commission spokeswoman said the prohibition did not apply to CFDs in Australia, because they were derivatives. But without the ability to take short positions on the market as a hedge, most CFD providers had little choice but to stop offering “short” CFDs.

The British ban extends until the end of the year while in the US it lasts until October 10. Australia had put its ban in place for one month.

As the Australian regulator has now discovered, its haste has caused further complications. Shorting takes many forms, notably among derivatives, in which shorting can take place via contracts for difference, equity swaps and put options. Moreover, banning shorting can prevent traders from hedging their risk via physical equities.

As a result ASIC has been forced to grant a number of exemptions to the shorting ban. Yesterday, the regulator clarified that market participants were still able to conduct both buy and sell transactions in all ASX exchange-traded options and market makers could hedge those options transactions through covered short selling in the physical market. ASIC also said it would exempt short selling as part of arbitrage transactions involving dual-listed entities, such as BHP Billiton and Rio Tinto.

That all suggests the correct approach is not to outlaw short selling but to ensure transparency by requiring greater disclosure. Shorting is a very risky exercise, as there is no limit to the downside. The stampede effect that short sellers have been able to achieve in stocks such as Allco Finance, Babcock & Brown and Macquarie is only possible when market participants must guess at what is happening.

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