Belgium, France, Italy and Spain have introduced short-selling bans on certain financial stocks in a move that, in the words of the European Securities and Markets Authority (ESMA) on Thursday, aims "either to restrict the benefits that can be achieved from spreading false rumours or to achieve a regulatory level playing field".
Critics of such a move claim it sends the wrong message to the markets and their investors. In keeping with this view, a global study of the short-selling ban introduced during the financial crisis of 2008 and 2009 claims that, rather than preventing share prices from sliding, a short-selling ban instead severely reduces market volatility and restricts the flow of information to the market. The study carried out by Cass Business School, part of City University London, examined the impact of the ban on 30 countries using data from nearly 17,000 stocks.
"According to our study, the knee-jerk reaction of most stock exchange regulators around the globe had a severely damaging effect on market liquidity," commented co-author of the report Professor Alessandro Beber from Cass. "This was especially pronounced for stocks with small market capitalisation, high volatility and no listed options."
Beber said the fall in liquidity seen as a result of the ban was particularly dangerous because it came at a time when bid-ask spreads were already high as a result of the financial crisis, and investors were desperately seeking liquid security markets due to the freeze of many fixed-income markets.
"Our evidence [...] should send a strong message to regulators that fresh bans on short-selling could cause more harm than good", Beber added. The ban also failed to achieve its overall aim of restoring order to the market and preventing the collapse of share prices, the report finds. "In contrast to the regulators' hopes, the overall evidence indicates that short-selling bans at best left stock prices unaffected and at worst may have contributed to their decline," Beber said.
Though the effects of such a ban may be negative, the impact is likely to be short-lived, reducing price volatility "for a few days at best", according to financial advisory firm Kinetic Partners' Andrew Shrimpton. "As demonstrated in 2008, when similar bans were in place, volatility increases after a day or so because liquidity in the stocks is significantly reduced," he added. On a broader scale, however, Shrimpton says that the ban will reduce the ability for banks to raise capital and increase the risk of a full blown recession in the countries that have adopted it.
Yet, for now, it appears that European banking stocks are finding support in the markets, with the Paris CAC40, Madrid IBEX 35 and Milan FTSE MIB all rallying in excess of 5% on Friday, largely supported by banking and insurance stocks. However, "deep questions remain over the sincerity of [...] the credibility of the short selling ban itself," commented Joshua Raymond, market strategist at City Index, this morning.
The Cass study on the impact of the short-selling ban will be published in the forthcoming edition of the Journal of Finance.
