Australia Extends Short Selling Ban on Financials

Oh dear. The Australian Securities and Investments Commission has extended the ban on short-selling financials to 6 March 2009.

But what were they thinking?

ASIC has described the decision as a cautious one, responding to the renewed selling in financials in London and New York that coincided with the lifting of the ban on short selling financials in the UK on 16 January 2009.

But by acting differently to other regulators globally, and in view of Australia's large weight to financials, it is a risky decision that is likely to further tarnish our reputation as a reliable financial market.

There is no evidence that such bans have been effective in achieving higher share prices, or that when not in place, have resulted in lower share prices. A relative outperformance of financials in Australia of 8 percentage points over the period since the ban on non-financials was lifted has been touted as evidence that the ban has worked. But there are many factors at work in determining share prices not just short selling. The influence of short selling on share prices is just unsubstantiated heresay based on a fear of predatory practices; we need some solid evidence.

And what is the regulator, supposedly responsible for ensuring free and fair markets, doing trying to rig higher share prices for financial stocks? At the least they are terribly conflicted. At worst they are driving out investors (who want fair prices and access to short selling as a tool to manage risk), reducing market liquidity and the attractivess of the Australian market to raise capital and contributing to the undermining of Australia as a regional financial centre.

Impact of Short Sales Restrictions on Share Prices

A recent paper by Ian Marsh and Norman Niemer dated 30 November 2008 titled "The Impact of Short Sales Restrictions" is a timely one given some governments and regulators, including in Australia, are still forming views on the appropriate regulatory approach.

The authors were expecting to see an increase in skewness and a decrease in kurtosis as a measure of whether the short sale prohibition had been effective.

They found that the imposition of short selling restrictions had no discernible impact on the behaviour of stock returns.

The analysis was limited by the small number of observations when the restrictions were in place. In Australia of course the bans were in place longer and remain in place for financials. This may make further analysis more useful.

The study highlights the extreme position adopted by Australian regulators. The following table taken from p22 of the paper shows that Australia was the only country among the 17 developed countries in the sample that banned covered short sales of non-financial stocks as well as financial stocks - see highlighted column.

SEC's Cox Regrets Short Selling Ban

US Securities and Exchange Commission (SEC) Chariman Christopher Cox said he regrets his handling of the financial crisis and in particular the banning of short selling financial stocks.

The SEC and the UK's Financial Services Authority (FSA) introduced a temporay ban on short selling financial stocks like Morgan Stanley and Citigroup on 19 September 2008. The ban was lifted on 9 October 2008.

The SEC's office of economic analysis is still evaluating data from the temporary ban on short-selling. Importantly, Cox conceded that preliminary findings point to several unintended market consequences and side effects caused by the ban, such as reduced market liquidity.

"While the actual effects of this temporary action will not be fully understood for many more months, if not years, knowing what we know now, I believe on balance the commission would not do it again," Cox told Reuters in a telephone interview from the SEC's Los Angeles office late on Tuesday. "The costs (of the short selling ban on financials) appear to outweigh the benefits."

The SEC imposed the temporary ban under intense pressure from the Federal Reserve and Treasury Department which insisted it was crucial to the short-term survival of these institutions, Cox said.

A few weeks after the temporary ban was lifted, global markets were again dropping precipitously, U.S. banks were begging the SEC to reinstate its short-sale ban and there was talk of shutting the markets down.

Australia faced a simliar set of circumstances to the US, except that the the Australian financial sector was in relatively stronger shape. The Australian regulator, the Austrailan Securities and Exchange Commission (ASIC), was under intense pressure from Australian banks, government agencies and the press to follow the lead of the US and UK regulators.

ASIC did respond on Friday 19 September 2008 in concert with the US and UK regulators and then, remarkably, imposed a sharper regulatory response on 21 September 2008, imposing a total ban on short selling. This temporary ban on short selling was not lifted until 13 November 2008 (over a month after the ban in the US was lifted), and the ban on financials remains, with a lift being foreshadowed (but not promised) for 27 January 2009.

How will history judge Australia's policy response? Given the deeper and more protracted bans, will the unintended consequences of these actions be even greater than Cox is indicating for the US?