It was expected that financial stocks would rally on the first day of the short-selling ban in Australia, back on September 21. The ASX200 financials index (XFJ) gained 5 per cent that day, as shares in ANZ increased by 8.1 per cent, Commonwealth Bank of Australia by 4.4 per cent, Westpac by 4.9 per cent and NAB by 5.65 per cent.
But as the market continued its decline, with much volatility, in the
following days, Rick Steele, chief
executive of market neutral hedge fund
TechInvest, questioned whether the ban
was a “one-day wonder”. The ban, imposed by the Australian Securities and Investments Commission (ASIC), was intended to shield the Australian sharemarket from shortsellers worldwide who found themselves deflected from other exchanges by similar regulatory interventions.
Tony D’Aloisio, chairman of the regulatory body, also pitched the ban as a “circuitbreaker” that could restore confidence. But the shorting bans imposed by western and Asian market regulators were never going to stabilise markets destabilised by powerful macroeconomic forces, Steele said. An absence of short-sellers would not encourage flows of credit, halt deleveraging and resultant forced-selling into falling markets, or prevent redemptions.
Don Hamson, managing director of Plato Investment Management, said short-selling was not the cause of declines in the share prices of financial companies that were seen as under siege: rather, the prices of these companies fell because they were
“overleveraged and poorly-managed”. D’Aloisio shared this view: some downward price movements “reflected the market being hard on companies with high asset values and high gearing,” he said.
While ASIC judged that shortselling was not creating a disorderly market, its primary focus was the disclosure of covered short-selling. On November 19, when ASIC began allowing covered short-sales of non-financial stocks, the ASX 200 had fallen by -29.82 per cent, while the XFJ had sunk by -30.7 per cent, since the inception of the ban on September 21. While the powerful macro forces make it difficult to determine the precise effects of the ban, some managers have run analyses of its impacts on share prices, trading volumes and volatility.
Without short-selling, pricing inefficiencies distorted the true value of securities, according to Tribeca Investment Partners. As buy-sell spreads of securities widened and trading volumes thinned out, liquidity contracted. An increase in market volatility was observed, too. Tribeca found the range between the highest and lowest daily trading prices of the median stock doubled after the ban took effect. However volatility spiked globally during this time: measurements recorded by the Volatility Index, which gauges market expectations of near-term volatility conveyed by S&P500 stock options, ranged from 36.92 on September 29 as high as 89.53 on October 24, as markets shed capital.
Plato found the liquidity of the ASX300 was reduced and intra-day volatility increased after the ban was put in place.
The average level of trades for each
stock fell by 13.7 per cent, or 279 trades each day, in the 15 days after the ban was introduced, according to Plato. A broader analysis, which covered daily trading data from January 2 to October 13, found the total volume of shares traded fell by approximately 194 million shares traded daily after the ban took effect.
An observation of trading activity
on the October 6 Labour Day public
holiday in NSW provided Plato with
a benchmark for low trading volumes.
Plato concluded that, as a rough estimate,
liquidity contracted during the ban to a
level roughly half of that measured on
the public holiday, reducing liquidity,
slowing the transmission of negative
news to the market and increasing the
costs of trading. The analysis also
identified an increase in the
volatilities of stocks. Absolute
intra-day volatility, a measure of the
ratio of the highest and lowest transaction
prices of a stock on a given day, rose
from 5.4 to 7.7 per cent, while idiosyncratic
or ‘index-relative’ volatility, which
subtracts the absolute volatility of the
index from the same measure of a given
stock, increased from 3.3 to 4.3 per
cent.
In its defence of the ban, ASIC argued that the lack of transparency of short-sales weakened investor confidence, increased the cost of capital and reduced trading. But the absence of shorting has brought the same consequences, Steele said.
He said the shorting bans in other
developed markets presented Australia with a “remarkable” opportunity to stand up for the principle of free markets.
Since short-selling provides companies with a deeper and more liquid market in their securities, lowers the cost of trading for investors and
improves price discovery, Steele
reasoned that investors prefer to trade
in freer markets and that companies
would want to raise capital there. By
following the moves of regulators in New York, London and Tokyo,
Australia
failed to “take leadership”. But D’Aloisio said recent events had vindicated the regulator. “Were we correct? We believe we were…Our approach has not been without controversy: unannounced, sharp changes in the law are not good for markets.”
He said the Italian market regulator’s
ban on naked shorting, imposed when
Australia
had banned all shorting trades, resulted
in heavy selling of one of the country’s
largest banks, which later caused a ban
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sales, then all shorts. “We believe we avoided similar disruption on our market by placing the ban on when we did,” D’Aloisio concluded. The new shorti ng rules Alternatives
managers say the new reporting
requirements of short sales should follow global practice, in which investors, or their custodian or prime brokers, report shorting interest, to the regulator or the exchange.
Short interest is measured by the
total number of shares in a company that
have been sold short, and is reported as a percentage of outstanding shares in a company. ASIC now requires short-sellers and the brokers they trade through to report shorting transactions on a daily basis, so the ASX can release a report that shows these trades, in aggregate, one hour before trading starts on each working day. Unsettled trades are not reported.
Kim Ivey, chair of the Australian
chapter of the Alternative Investment
Management Association, said capturing daily trade data would not provide the amount of short interest in a listed company, or the rate at which that short interest is changing. He said that reporting daily trade data would “significantly distort” the actual shorting activity of a stock because it failed to show the size of the position and its implied impact on the price of the stock. ASIC’s focus on daily information is understandable, but fortnightly reporting of the short interest in a stock, which is practiced in the US, would serve the market well, Steele said.
He
said there is rarely any significant
change in the short interest of a stock
from one fortnight to the next. When publicised, short interest positions can inform the investment and risk management decisions made by managers. For example, securities with a lot of short interest are susceptible to a short squeeze if new, positive information about that security hits the market.
But using the ASX short-selling reports to arrive at short interest positions would be a big, impractical exercise, Steele said.
It would be more efficient if
custodians (rather than brokers) supplied
managers’ short positions to the
exchange since they capture, settle and report this data each day on a tradedand- settled basis, Steele said. Offshore managers investing in the Australian market use subcustodians that could provide this information. Also, custodians would be more suitable to provide this information since brokers do not always carry a record of holdings for clients, and investors sometimes use a number of brokers to conduct trades, Steele added.
ASIC believes a staged lifting of
the ban is appropriate due to the
volatility in the market. As Investment
& Technology went to press, its position was that the ban on short-selling financial stocks would remain at least until January 27, 2009.
