UK and US ban short-selling

Friday, 19 September 2008 11:11

Short-selling, thought to be to blame for the collapse of HBOS, has been banned by the Financial Services Authority (FSA) and US authorities.

Restrictions on short-selling, a practice whereby market traders bet on share prices falling in a bid to create capital from the sale and purchase of assets, will be imposed until January 16th 2009 in the UK - a total of 120 days.

The ban means traders can no longer move on the falling of financial stocks. The UK regulator is also forcing traders to disclosure of all net short positions in excess of 0.25 per cent of the ordinary share capital of a firm.

In the US, the Securities and Exchange Commission (SEC) has called "a time-out to aggressive short selling in financial institution stocks", because of "the essential link between their stock price and confidence in the institution".

An SEC statement read: "Under normal market conditions, short selling contributes to price efficiency and adds liquidity to the markets. At present, it appears that unbridled short selling is contributing to the recent, sudden price declines in the securities of financial institutions unrelated to true price valuation."

The SEC ban lasts until October 2nd 2008, although it may be extended.

It is believed that short-selling may have been at the root of the tumbling share prices of HBOS earlier this week, which led to its rescue by Lloyds TSB.

FSA chief executive Hector Sants told Channel 4 News: "To be quite clear we haven't banned all short selling. We banned certain types of short selling; types of short selling that we believe are contributing to unreasonable volatility in financial stocks. So the objective is to improve market quality; make the market work better."

He added: "We have always said and haven't changed our view on this; that short selling in moderation is a legitimate investment technique.

"It is a legitimate investment technique in normal market conditions so what we are doing here is reacting decisively to abnormal market conditions. And where we are finding the most abnormal market conditions are in financial stocks, which of course reflects the fact that we are in the middle of a global financial crisis."

Mr Sants also denied there was external pressure of the FSA to move on the ban on short-selling - despite the prime minister stating yesterday he was intending to "clean up the financial system".

He also explained recent shocks to financial stocks were not solely due to short-selling, but the action of traders made the problem worse.

"We are not in any way suggesting that the recent financial share moods are entirely due to short selling," he told Channel 4.

"That's clearly not the case. There are a whole series of legitimate reasons why investors have been worried about financial stocks. But we do believe they are exacerbating the situation and there are certainly times when we feel that the quality of markets is very severely adversely affected."

Typically employed by hedge fund managers, short-selling involves the borrowing and sale of an asset in the belief that its share price will fall.

The assets, whether shares, currency or contracts, can then re-acquired at a lower price and returned to an investor, with the trader keeping the difference.

Callum McCarthy, FSA chairman speaking at the Lord Mayor's City Banquet at the Mansion House last night said the measure was "designed to have a calming effect - something which the equity markets for financial firms badly need. I hope that practitioners will support both the ambition and the chosen means of achieving it".

He added: "There is a danger in a trading system which allows financial institutions to be targeted and subject to extreme short selling pressures, because movements in equity prices can be translated into uncertainty in the minds of those who place deposits with those institutions with consequent financial stability issues.

"We have seen acute examples of this phenomenon in both London and New York this week."

Today, SEC chairman Christopher Cox said: "The Commission is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets.

"The emergency order temporarily banning short selling of financial stocks will restore equilibrium to markets. This action, which would not be necessary in a well-functioning market, is temporary in nature and part of the comprehensive set of steps being taken by the Federal Reserve, the Treasury, and the Congress."

A comprehensive review of the FSA's rules on short-selling is to be carried out in January.

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