Short-Selling Bans Only Delay the Inevitable

(Bloomberg Opinion) -- Things are getting real for traders. Italy and Spain have triggered a one-day ban on short selling certain stocks on their respective stock exchanges, and also on U.K. Exchanges, after Thursday’s markets carnage.

It’s done the trick for now as both markets led a recovery rally in Europe on Friday morning, but there’s no news yet on whether the prohibition will be extended. Other European regulators are all doing their own thing; symptomatic of the wider European Union response of dither and delay. A temporary piecemeal fix is not going to solve much bar buying a bit of breathing room. Short sellers tends to come back as soon as the ban is lifted.

And if Europe really wants to take action on short selling in a crisis, it should do it as one. Otherwise you just encourage the hedge funds to move onto a different target while a localized prohibition is in place.  

It’s never a happy sign when stock exchange regulators reach for a short-selling ban. Preventing the free flow of equity markets can just store up problems and deter investors in the longer term. Both Italy (85 stocks) and Spain (69) have chosen just the most oversold securities to include in the ban, which is perhaps an understandable reaction following a total meltdown. South Korea made a more draconian move by banning short selling on all stocks and exchanges for six months.

In a short sale, a trader borrows stock from a broker or bank and sells it at the prevailing market price, betting that a decline will allow him or her to return the shares to the lender after repurchasing them at the new, lower value and pocketing the difference. For the trade to work, some owner of the shares has to be willing to lend them to the short seller. Governments hate it because short attacks can gather a momentum of their own, which may not reflect fundamental problems in a company or other traded assets.

Banning short selling of equities may seem logical, as it does not prevent current holders from liquidating their holdings, but it does reduce liquidity by curtailing long and short trading. The prohibition was triggered several times during the euro crisis but it never really had a conclusive effect — it was more a move of desperation. There’s evidence that assets outperformed when a ban was in place, and underperformed when it was lifted. It was also used for certain sovereign bonds and related futures and option contracts. 

After European Central Bank President Christine Lagarde’s comments on Thursday whacked Italian government bonds, there’s a nervousness among traders that these bans might spread across many other European markets.

Perhaps there does need to be a wider discussion about funds lending out stocks in the first place, for other market players to be able to place short positions. My colleague Mark Gilbert has highlighted the stance that the world’s biggest pension fund is taking against this practice. In the meantime Europe needs to act as one and present a united front on this, as with everything else coronavirus-related.

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

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