“However, volumes have certainly dropped off and spreads widened as the shorting ban has removed liquidity in the market. So, at the very least we can say that the shorting ban failed to bring stability to the market and quite possibly made it worse.”
It is not only long/short managers and their clients who suffered during the ban. Shorting is used in broader market functions such as where a broker borrows stock to facilitate a trade or, more importantly, by arbitrageurs to ensure efficient pricing between futures, options and convertible markets and the physical stock market.
Most short selling is done as ‘pair trading’, with the manager using the money from selling one company’s stock to go long in a similar company – betting on the relative performance between the stocks.
Fenton points out that there are very few net short-selling managers in the world.
(There are none in Australia and only a handful, even, in the US. These managers are interesting: they tend to have long periods of underperformance followed by shorter periods of massive outperformance.)
“Over the last year in Australia we have seen short sellers take the brunt of the blame for the fall in the market and many stocks in particular,” Fenton said. “These companies include Centro, Allco, ABC Learning, Octaviar, Babcock & Brown and their vehicles and Macquarie and more recently Fortescue. Most of the companies are languishing near their lows, but we believe that in many cases short sellers have long since left the register. In fact, several of these companies have now been placed in administration… As many share prices have continued to be annihilated during the short selling ban it should be obvious that short sellers are not to blame every time a share price drops.”
The ban on shorting financial stocks is scheduled to continue until January 27, but equitised long/short managers tend not to be so concerned about this because most financials are very large, so an investor can take a significant bet against them by simply not owning them. There are also five non-financial stocks in the ban, including debt-laden Wesfarmers, which has a small APRA-regulated insurance business.
Similarly, the soon-to-be permanent ban on naked short selling does not seem to have caused much concern as this was a relatively small part of the market.