Short ban syndrome
17 September 2013
SLT takes a global view of short selling research, politics and lawsuits
Image: Shutterstock
The practice of selling a security that you do not own has been the subject of numerous debates, speculation, and misinterpretation鈥攑articularly over the last five years.
The old adage of banning the practice when markets are in turmoil, only to lift the bank when recovery is imminent, has been taken up widely by Europe.
Greece, Italy and Spain were just three European countries that brought the shutters down and promptly lifted them, citing recapitalisation and an indecisive election as just some of the reasons for the bans.
Short selling has also been the subject of complaints and lawsuits, particularly in the US. The Chicago Board Options Exchange paid out $6 million in penalties for failing to enforce rules to prevent abusive short selling.
But research coming out of the US has also sought to dispel commonly held opinions about the practice. Below is a glance at the lawsuits, the bans and the studies on short selling from country to country.
Europe
Greece鈥檚 capital markets regulator lifted a short selling ban on 15 July, after the country鈥檚 major banks were recapitalised.
It was in May that the Hellenic Capital Markets Commission (HCMC) decided to extend its ban on short selling until July, stating that the decision was due to the country鈥檚 recapitalisation plan.
In a statement, HCMC said that its board considered 鈥渢he process of recapitalising the lenders鈥� in its decision鈥攔eferring to the 鈧�50 billion set aside to inject capital into the country鈥檚 four big banks, and to scrap some smaller lenders.
The European 网爆吃瓜 and Markets Authority (ESMA) published its opinion on the emergency measure, stating that it was appropriate and proportionate in relation to the country鈥檚 current situation.
鈥淓SMA considers that the measure which is targeted at credit institutions admitted to trading on the Athens Stock Exchange remains appropriate and proportionate to address the ... threats that persist in Greece.鈥�
鈥淸The authority] considers that the duration of the measure is justified and appreciates the HCMC鈥檚 statement in its notification of intent whereby the measure may be lifted during the period of enforcement of the measure, if appropriate.鈥�
In February, Italy banned short selling of shares in major Italian banks after an election result caused shares in them to drop sharply.
The country鈥檚 general election results on 25 February pointed towards a hung parliament鈥攚here no single party gains a majority of cast votes and so one or more must team up to form a government鈥攔esulting in the departure of prime minister Mario Monti.
In a press conference, Monti said that he hoped the vote would benefit the Italian people and calm financial markets.
But shares in Italian banks on Milan exchanges fell sharply in response to the news that a hung parliament was likely in the country, leading financial markets regulator Consob to ban short selling of four of them on 26 February.
In statements, Consob blamed significant fall in prices of the shares.
David Lewis, EMEA head of SunGard Astec Analytics, said that short selling does not increase volatility in markets and that banning it can actually increase the practice.
鈥淏ans on short selling are often politically driven and usually a sign of underlying economic problems. Many studies have shown that such bans do little to support share prices whilst damaging liquidity and widening spreads which are both bad news for investors. Short selling allows proper price discovery and is part and parcel of an efficient capital market.鈥�
鈥淭hey say in war that the wrong action is usually better than inaction. Perhaps this is the case here.鈥�
鈥淢any European countries have previously imposed bans on short selling. Our own study of the short selling bans in Spain (which were finally lifted at the end of January) showed there was no real change in the volatility of the market for the duration of the ban. It also showed little correlation between the direction of share price movement and the subsequent imposition of a ban.鈥�
In the same month, Spain lifted its ban on short selling as markets rallied.
Spanish regulator Comisi贸n Nacional del Mercado de Valores (CNMV) extended an existing ban on short selling for an additional week in October 2012 and submitted a proposal to the European 网爆吃瓜 and Markets Authority (ESMA) to impose a further three-month ban, effective from 1 November.
Spain lifted the short selling ban as the IBEX 35 Index rallied and the country鈥檚 banks took steps to repair their balance sheets amid deep austerity measures.
The US
A July report from Texas argued in favour of naked shorting, stating that accounting fundamentals were highly significant in explaining naked short sales.
The report, authored by Harrison Liu of the University of Texas San Antonio, and Sean McGuire and Edward Swanson of Texas A&M University, showed that鈥攃ontrary to accepted belief鈥攁ccounting fundamentals are highly significant in explaining naked short sales.
鈥淐iting a widely held belief that naked short selling is not based on company fundamentals, the SEC (2008) has substantially tightened Reg. SHO close-out regulations in an effort to eliminate naked short selling,鈥� said the report鈥檚 foreword.
It added that naked short sales contain incremental information about future stock prices.
鈥淎bnormal returns from a long/short trading strategy that buys (sells short) shares with low (high) short interest are more than seven times larger using naked and covered short interest, compared to returns using only covered short interest (15.2 percent vs. 2.1 percent annualised).鈥�
The study鈥檚 aim was to show that recent regulatory actions to eliminate naked short sales are likely to impede informed arbitrage and reduce market efficiency.
But feelings towards the practice were very different in Waco, Texas, as an illegal short-selling complaint was made to the US 网爆吃瓜 and Exchange Commission (SEC) by Life Partners Holdings CEO Brian Pardo.
Pardo announced that evidence was found of 鈥渃oordinated market manipulation鈥� and naked short selling of Life Partners鈥檚 stock in and around 26 September 2012, and likened the practice to terrorism.
Pardo said that it was a 鈥渢ragedy to realise that there are well-known financial entities that intentionally try to destroy companies with these abusive tactics, without any regard for the lives of the workers and the investors they ruin.鈥�
鈥溾�� This small group has hijacked our financial markets for their own gain. I just hope that the SEC will use the clear evidence we have provided to them to bring those who are working against our economy to justice. In my view, naked short selling is a form of financial terrorism.鈥�
In Washington, the SEC fined the CBOE for short selling failures.
The Chicago Board Options Exchange (CBOE) paid a $6 million penalty and implement major remedial measures for 鈥淸failing] to enforce or even fully comprehend rules to prevent abusive short selling鈥�.
The US SEC said at the time that the fine was the first to be levied against an exchange for violations relating to its regulatory oversight.
An SEC investigation found that CBOE failed to adequately police and control a conflict for one of its member firms, online brokerage and clearing agency optionsXpress, which the commission charged with engaging in an abusive naked short selling scheme in April 2012.
But, the SEC did take into consideration CBOE鈥檚 attempts to rectify the situation after the investigation began. The exchange reorganised its regulatory services division, hired compliance and regulatory officers, updated written policies and procedures, and hired a consultant to review its enforcement programme.
Asia
In August, the State Bank of India recommended a shorting ban.
The State Bank鈥檚 chairman, Pratip Chaudhuri, told a crowd that the bank recommended to the finance minister in India that short selling should be banned. He made the comments while opening the 15,000th branch of the bank in Sooranam, Southern India.
It was only in July that India鈥檚 insurance regulator allowed insurers to lend a maximum of 10 percent of their securities, in rules hoped to revive the country鈥檚 market.
The Insurance Regulatory and Development Authority (IRDA) has been seeking comment as of August last year relating to insurers participating in a securities lending and borrowing scheme.
Comments were received over the course of a year from the various stakeholders including life insurers, general insurers and other entities, along with suggestions for the controls needed.
鈥淎fter examination of the comments received, it is observed that insurers can generate extra yield on the securities held in their custody by lending securities through [the] SLB mechanism,鈥� said an IRDA statement.
Kuala Lumpur鈥檚 stock exchange Bursa Malaysia released new guidelines for both securities lending and borrowing, as well as short selling.
CEO of the stock exchange Dato鈥� Tajuddin said at the time: 鈥淲e will continue to build for the future to further strengthen our breadth and depth of the markets. Amongst our focus areas will be the regulated short selling and securities borrowing and lending which is necessary for Malaysia to achieve developed market status.鈥�
Short selling regulations were introduced in 1996, relatively early for what was then a very emerging market. The business didn鈥檛 last long. At the heart of the Asian crisis less than a year later, securities borrowing and lending was suspended on all shares listed on Bursa Malaysia. ??
In 2007, a new system was introduced. The Bursa SBL system, offered by Bursa Malaysia 网爆吃瓜 Clearing, specifies which shares are currently eligible for borrowing and lending鈥攖he numbers vary, but most publicly traded shares are permitted.
In June, short selling in Japan was on the up. Shorting in Japanese equities showed signs of increasing in the last week of May as they moved into bear market territory amid concerns the US Federal Reserve would begin to taper its bond buying programme and the Bank of Japan will hold monetary policy where it is.
SunGard Astec Analytics statistics at the time showed that borrowing of Japanese equities has been on the increase, even as the benchmark Nikkei has been sliding lower.
The old adage of banning the practice when markets are in turmoil, only to lift the bank when recovery is imminent, has been taken up widely by Europe.
Greece, Italy and Spain were just three European countries that brought the shutters down and promptly lifted them, citing recapitalisation and an indecisive election as just some of the reasons for the bans.
Short selling has also been the subject of complaints and lawsuits, particularly in the US. The Chicago Board Options Exchange paid out $6 million in penalties for failing to enforce rules to prevent abusive short selling.
But research coming out of the US has also sought to dispel commonly held opinions about the practice. Below is a glance at the lawsuits, the bans and the studies on short selling from country to country.
Europe
Greece鈥檚 capital markets regulator lifted a short selling ban on 15 July, after the country鈥檚 major banks were recapitalised.
It was in May that the Hellenic Capital Markets Commission (HCMC) decided to extend its ban on short selling until July, stating that the decision was due to the country鈥檚 recapitalisation plan.
In a statement, HCMC said that its board considered 鈥渢he process of recapitalising the lenders鈥� in its decision鈥攔eferring to the 鈧�50 billion set aside to inject capital into the country鈥檚 four big banks, and to scrap some smaller lenders.
The European 网爆吃瓜 and Markets Authority (ESMA) published its opinion on the emergency measure, stating that it was appropriate and proportionate in relation to the country鈥檚 current situation.
鈥淓SMA considers that the measure which is targeted at credit institutions admitted to trading on the Athens Stock Exchange remains appropriate and proportionate to address the ... threats that persist in Greece.鈥�
鈥淸The authority] considers that the duration of the measure is justified and appreciates the HCMC鈥檚 statement in its notification of intent whereby the measure may be lifted during the period of enforcement of the measure, if appropriate.鈥�
In February, Italy banned short selling of shares in major Italian banks after an election result caused shares in them to drop sharply.
The country鈥檚 general election results on 25 February pointed towards a hung parliament鈥攚here no single party gains a majority of cast votes and so one or more must team up to form a government鈥攔esulting in the departure of prime minister Mario Monti.
In a press conference, Monti said that he hoped the vote would benefit the Italian people and calm financial markets.
But shares in Italian banks on Milan exchanges fell sharply in response to the news that a hung parliament was likely in the country, leading financial markets regulator Consob to ban short selling of four of them on 26 February.
In statements, Consob blamed significant fall in prices of the shares.
David Lewis, EMEA head of SunGard Astec Analytics, said that short selling does not increase volatility in markets and that banning it can actually increase the practice.
鈥淏ans on short selling are often politically driven and usually a sign of underlying economic problems. Many studies have shown that such bans do little to support share prices whilst damaging liquidity and widening spreads which are both bad news for investors. Short selling allows proper price discovery and is part and parcel of an efficient capital market.鈥�
鈥淭hey say in war that the wrong action is usually better than inaction. Perhaps this is the case here.鈥�
鈥淢any European countries have previously imposed bans on short selling. Our own study of the short selling bans in Spain (which were finally lifted at the end of January) showed there was no real change in the volatility of the market for the duration of the ban. It also showed little correlation between the direction of share price movement and the subsequent imposition of a ban.鈥�
In the same month, Spain lifted its ban on short selling as markets rallied.
Spanish regulator Comisi贸n Nacional del Mercado de Valores (CNMV) extended an existing ban on short selling for an additional week in October 2012 and submitted a proposal to the European 网爆吃瓜 and Markets Authority (ESMA) to impose a further three-month ban, effective from 1 November.
Spain lifted the short selling ban as the IBEX 35 Index rallied and the country鈥檚 banks took steps to repair their balance sheets amid deep austerity measures.
The US
A July report from Texas argued in favour of naked shorting, stating that accounting fundamentals were highly significant in explaining naked short sales.
The report, authored by Harrison Liu of the University of Texas San Antonio, and Sean McGuire and Edward Swanson of Texas A&M University, showed that鈥攃ontrary to accepted belief鈥攁ccounting fundamentals are highly significant in explaining naked short sales.
鈥淐iting a widely held belief that naked short selling is not based on company fundamentals, the SEC (2008) has substantially tightened Reg. SHO close-out regulations in an effort to eliminate naked short selling,鈥� said the report鈥檚 foreword.
It added that naked short sales contain incremental information about future stock prices.
鈥淎bnormal returns from a long/short trading strategy that buys (sells short) shares with low (high) short interest are more than seven times larger using naked and covered short interest, compared to returns using only covered short interest (15.2 percent vs. 2.1 percent annualised).鈥�
The study鈥檚 aim was to show that recent regulatory actions to eliminate naked short sales are likely to impede informed arbitrage and reduce market efficiency.
But feelings towards the practice were very different in Waco, Texas, as an illegal short-selling complaint was made to the US 网爆吃瓜 and Exchange Commission (SEC) by Life Partners Holdings CEO Brian Pardo.
Pardo announced that evidence was found of 鈥渃oordinated market manipulation鈥� and naked short selling of Life Partners鈥檚 stock in and around 26 September 2012, and likened the practice to terrorism.
Pardo said that it was a 鈥渢ragedy to realise that there are well-known financial entities that intentionally try to destroy companies with these abusive tactics, without any regard for the lives of the workers and the investors they ruin.鈥�
鈥溾�� This small group has hijacked our financial markets for their own gain. I just hope that the SEC will use the clear evidence we have provided to them to bring those who are working against our economy to justice. In my view, naked short selling is a form of financial terrorism.鈥�
In Washington, the SEC fined the CBOE for short selling failures.
The Chicago Board Options Exchange (CBOE) paid a $6 million penalty and implement major remedial measures for 鈥淸failing] to enforce or even fully comprehend rules to prevent abusive short selling鈥�.
The US SEC said at the time that the fine was the first to be levied against an exchange for violations relating to its regulatory oversight.
An SEC investigation found that CBOE failed to adequately police and control a conflict for one of its member firms, online brokerage and clearing agency optionsXpress, which the commission charged with engaging in an abusive naked short selling scheme in April 2012.
But, the SEC did take into consideration CBOE鈥檚 attempts to rectify the situation after the investigation began. The exchange reorganised its regulatory services division, hired compliance and regulatory officers, updated written policies and procedures, and hired a consultant to review its enforcement programme.
Asia
In August, the State Bank of India recommended a shorting ban.
The State Bank鈥檚 chairman, Pratip Chaudhuri, told a crowd that the bank recommended to the finance minister in India that short selling should be banned. He made the comments while opening the 15,000th branch of the bank in Sooranam, Southern India.
It was only in July that India鈥檚 insurance regulator allowed insurers to lend a maximum of 10 percent of their securities, in rules hoped to revive the country鈥檚 market.
The Insurance Regulatory and Development Authority (IRDA) has been seeking comment as of August last year relating to insurers participating in a securities lending and borrowing scheme.
Comments were received over the course of a year from the various stakeholders including life insurers, general insurers and other entities, along with suggestions for the controls needed.
鈥淎fter examination of the comments received, it is observed that insurers can generate extra yield on the securities held in their custody by lending securities through [the] SLB mechanism,鈥� said an IRDA statement.
Kuala Lumpur鈥檚 stock exchange Bursa Malaysia released new guidelines for both securities lending and borrowing, as well as short selling.
CEO of the stock exchange Dato鈥� Tajuddin said at the time: 鈥淲e will continue to build for the future to further strengthen our breadth and depth of the markets. Amongst our focus areas will be the regulated short selling and securities borrowing and lending which is necessary for Malaysia to achieve developed market status.鈥�
Short selling regulations were introduced in 1996, relatively early for what was then a very emerging market. The business didn鈥檛 last long. At the heart of the Asian crisis less than a year later, securities borrowing and lending was suspended on all shares listed on Bursa Malaysia. ??
In 2007, a new system was introduced. The Bursa SBL system, offered by Bursa Malaysia 网爆吃瓜 Clearing, specifies which shares are currently eligible for borrowing and lending鈥攖he numbers vary, but most publicly traded shares are permitted.
In June, short selling in Japan was on the up. Shorting in Japanese equities showed signs of increasing in the last week of May as they moved into bear market territory amid concerns the US Federal Reserve would begin to taper its bond buying programme and the Bank of Japan will hold monetary policy where it is.
SunGard Astec Analytics statistics at the time showed that borrowing of Japanese equities has been on the increase, even as the benchmark Nikkei has been sliding lower.
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