In response to the market disruption caused by Covid 19, some regulators banned short-selling in attempt to reduce volatility, but have the bans worked?
At Sharegain, we’ve been analysing the data on short selling bans and our Founder and CEO, Boaz Yaari recently shared his thoughts with Bill Foley on Securities Finance TV.
Bill Foley: Hello and welcome to Securities Finance TV, I’m Bill Foley.
Short-selling is a much debated practice at the best of times. But when we see severe market disruption, the arguments for, and against, grow louder and more frequent. The recent market turbulence resulting from the COVID-19 pandemic saw a number of regulators ban the practice and this move once again split opinion.
But how effective are short-selling bans?
To discuss this, I’m joined by Boaz Yaari, Founder and CEO of Sharegain, Boaz thanks for joining me.
Boaz Yaari: Thanks for having me.
Bill Foley: Boaz, your team at Sharegain have been analysing the impact of the short-selling bans imposed in response to the recent crisis. What are you seeing?
Boaz Yaari: Well, it’s very interesting to see. We’ve been looking at these different short-selling bans and we tried to compare them to 2008 and we saw some very interesting things. In 2008, there were about 20 different short-selling bans applied in 20 different jurisdictions, including all major economies.
In 2020, it was reduced by half. Ten regulators implemented short-selling bans and the big three developed market economies – the US, UK and Germany – actually decided not to apply them.
In the UK, the FCA came in and said on their market statement on March 27 that they see the aggregate net short-selling activity that was reported to them was actually, in terms of percentage of total market activity, was low. So they were very comfortable in not applying a short-selling ban and they said very clearly there was no evidence that short-selling was behind the recent market selloffs. So that divergence really caught our eye and it was very interesting for us to see.
So we took a step further and we thought “let’s review those 10 different economies, those 10 jurisdictions that did implement bans and look at the data, at what does the data show”. On our website we published an open page that tracks the bans and moreover measures their effectiveness against the MSCI World Index. What you see is that countries like Spain and France have actually under-performed MSCI World: France by -4%, Spain by -6%. Italy over-performed the MSCI Index but only by 2%. In Asia, Indonesia under-performed by 5%, Malaysia -14%, and South Korea over-performing by just 2%.
So effectively what we are seeing is that most economies haven’t really outperformed the global index and that goes a long way to explaining how effective those bans are.
Now what we see is that regulators as a whole are doing a big disservice to investors with long positions by introducing short-selling bans.
Why? Well if you look at European economies, all the big three economies that introduced short-selling bans have since under-performed the Stoxx 600 index. It has rallied about 15% from mid-march to today, whereas economies like France, Spain and Italy have all done less.
And more importantly, if you’re looking at buying securities, one of the most important when you’re buying stocks is the bid offer spreads, ie. the liquidity. And it’s been long argued that short seller contribute to better liquidity and that translates into narrower, or tighter, bid offer spreads. And the data shows that with these countries that implement short-selling bans, the stocks were 7% tighter before the crisis on the bid offer spreads. After the restrictions, they became 8% wider than the average of the Stoxx 600.
If you think about it, that’s a 15% increase in bid offer spreads, which effectively translates into higher transaction costs for buyers.
Bill Foley: So supporters of short-selling would often say that price evidence is helped as well as liquidity, so some evidence there. Does that tie in with your own findings and views?
Boaz Yaari: Yea absolutely.
Bill Foley: So given your findings, the WFE paper and other evidence that bans don’t work, what do you think will happen in the next crisis? Will we see another round of bans?
Boaz Yaari: Well, I think big economies like the UK, Germany and the US have learnt their lesson since ’08 and understood how ineffective short selling bans are. You know, the former head of the SCC Christopher Cox even said in an interview he regretted the short selling bans. He said “on balance, the commission would not do it again… the costs appear to outweigh the benefits”. And we’ve seen this time over a real divergence in countries implementing short-selling bans, which I think is a very good sign going forward.
Saying that, are we saying this is the last crisis bans will be applied? I think that’s a bit too general. I think at the end of the day it depends on the nature of the crisis.
In 2008 you had a confidence crisis in the financial industry and in banking. When you have a confidence crisis, sometimes you need to get ahead of it and just apply different restrictions like short-selling bans to contain the situation.
However, this time over in the COVID-19 crisis, it’s a much different crisis. It relates to repricing of risk and the macro outlook and the fact we’re probably heading into a recession. So that repricing needs to be reflected in financial markets and one of the [results] can be quite abrupt movements in stocks and that’s fine, they will find a clearing price, albeit lower, and then they can trade from it onwards.
Bill Foley: So maybe not an end to short-selling bans but perhaps a change in their usage and lighter-touch in their application.
What impact do these bans have on the securities lending market. Have they impacted revenue at all?
Boaz Yaari: Certainly, and as a temporary measure, they had a temporary effect on demand and that applied as lower volumes and lower revenues, but that was like I said temporary.
Securities lending as a whole was largely unaffected because it saw demand coming in from other jurisdictions or the likes of ETFs. Even in Europe ETFs were exempt from the short-selling restrictions.
I think on the whole, this crisis, while being very tragic and unfortunate, is a good tail-wind from a securities lending point of view because financial crises create higher volatility, higher volatility creates higher demand to borrow securities and higher lending rates. The lack of clarity in terms of the future for us, who will be the winners and losers in terms of companies and in terms of economies, that creates a lot of opportunities from a securities lending point of view.
Bill Foley: So some impact for securities lending but a positive impact going forward.
It will be interesting as well to assess the impact of short-selling restrictions being eased and I’d invite you back to talk us through that.
Boaz Yaari: Yea listen, thanks for having us, we will obviously track it and we’d be happy to share the data and the analysis.
Bill Foley: Boaz, thanks for joining us once again and thank you for watching. Speak to you soon.