No evidence short selling drives market falls, says UK’s FCA
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No evidence short selling drives market falls, says UK’s FCA 24 March 2020London Reporter: Drew Nicol
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Short selling is a critical underpinning of liquidity provisions and there is no evidence it has driven the recent market falls, according to the UK’s Financial Conduct Authority (FCA).
The markets watchdog confirmed that despite the major volatility fuelled by the COVID-19 pandemic, the UK’s markets “have continued to operate in an orderly fashion”.
The FCA’s comments come after regulators in France, Italy, Spain, Belgium and Greece imposed bans on taking new short positions or increasing existing positions.
Other regulators in the Middle East and Asia have also initiated various actions to curb the taking of short positions.
One-day lockdowns were implemented on a limited number of the worst effected shares in France, Italy and Spain, before these were extended to one month. Italy opted for a three-month ban.
In contrast, the FCA has only mirrored bans for in-scope shares where requested by those national competent authorities (NCAs) but has stopped short of imposing its own ban for local markets.
In a statement explaining its rationale, the FCA says that aggregate net short selling activity is low as a percentage of total market activity and has decreased in recent days.
“It will continue to fluctuate, but there is no evidence that short selling has been the driver of recent market falls,” the FCA adds. “A great many investment and risk management strategies rely on the ability to take ‘long’ and ‘short’ positions.”
The market regulator further notes these strategies benefit a wide range of ordinary investors including the pension funds for employees of companies and local government, as well as being a “critical underpinning of liquidity provisions”.
The FCA’s stance has been broadly welcomed by the securities lending market, with several commentators noting that the familiar pattern of short sellers being blamed and punished for a market downturn caused elsewhere was starting to re-emerge.
“All too often in the past regulators immediately introduced short selling bans on an assumption that they are significantly contributing to market volatility,” says Sarah Nicholson, director of Consolo, a UK-based securities finance consultancy.
“With improved transparency measures introduced since the financial crisis in 2007/2008, regulators have much more data to rely on and can make better, more informed decisions,” she explains.
Nicholson further notes that, “after 2008, analysis suggested that the unwinding of short positions contributed significantly to maintaining liquidity in markets, but not contributing to volatility,” adding that “many regulators have subsequently stated they regretted short selling bans imposed at the time”.
The UK regulator's statement reinforces a similar stance taken by Germany's Federal Financial Supervisory Authority, which ruled out a ban on short selling a few days earlier.
The FCA’s decision to out itself as pro-short selling also comes as pressure continues to mounts on the European Securities and Markets Authority (ESMA) to take a leading role in stabilising markets under its mandate by imposing an EU-wide ban on shorting.
Advocates for a blanket ban are coming primarily from the European political sphere, but their calls for action have been countered by the German investment funds association, BVI,among others, who are raising questions around a ban’s effectiveness.
ESMA itself has not ruled out any emergency actions to assist ailing EU markets but commentators have noted that the likelihood of such action is decreasing as shorting activity decreases from highs seen in mid-February.
Utilisation of shares available to lend in the EU currently stands at around 6 percent, according to FIS’ Astec Analytics.
ESMA’s ability to curb short selling comes under Article 18 of the ESMA Regulation, which outlines how emergency powers can be accessed if certain criteria are met.
Accessing this toolbox requires approval by the European Council.
ESMA can initiate the process itself by making a public appeal to the council. Alternatively, the authority or the European Systemic Risk Board can make a confidential recommendation to the council that an emergency situation exists and action is needed.
The definition of an ‘emergency situation’ is defined in several ways that related to a systemic risk to economic and political stability to one or more EU members.
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