Careful What you Wish For
This the moral of the Aesop fable the Bee and Jupiter and is an appropriate caution to opponents of short selling. There has been a shrill chorus of opposition to short selling recently, including assigning it the blame for the recent market volatility and the plunge in credit and sharemarkets.
Following a ban on short selling by the UK's Financial Services Authority, the US Securities and Exchange Commission has ordered "In these unusual and extraordinary circumstances, we have concluded that, to prevent substantial disruption in the securities markets, temporarily prohibiting any person from effecting a short sale in the publicly traded securities of certain financial firms ..."
Now the Australian Securities and Investment Commission has banned all forms of short selling for the time being. Mr Tony D’Aloisio said ‘These measures are necessary to maintain fair and orderly markets in these exceptional times of global crises of confidence in financial markets. Because of the relatively small size and the structure of the Australian market, it is necessary to extend the prohibition to all stocks. To limit the prohibition to financial stocks, as has been done in the UK, could subject our other stocks to unwarranted attack given the unknown amount of global money which may be looking for short sell plays’.
I have sympathy with the sentiments - predatory short selling, if it is not illegal, is immoral.
However, short selling in its usual form is a key to the efficient operation of financial markets. Without it market makers (I note that the regulators give market makers relief), fund managers and other market participants would not be able to hedge risk.
The United States economy may have dropped down the international pecking order as it bears the cost of widespread global military intervention, but it still remains the centre of capital markets. It is the most efficient place to raise capital. At least until now.
The decision to ban short selling in certain securities opens the door for alternative markets to take leadership. It is in the interests of listed companies to have a deep and liquid market in their securities. It is also in the interests of investors.
While removing some participants (short sellers) may conjure (manipulate) a higher price in the short term, it will likely cause wider spreads and reduced demand for these securities in the medium term. Investors will prefer to trade securities in freer markets and this will drive companies to raise capital in those markets.
Global companies that list in the United States pay United States tax, will list in other markets and pay tax in other markets. This erosion in the US tax base will further weaken the United States' position in the world. These companies already employ a large number of staff in other countries as production has been outsourced to countries with cheaper sources of labour.
Australia had a remarkable opportunity here. Rather than join Karachi, London and the New York and respond by intervening in security pricing, we could have re-affirmed the principle of free markets.
I would expect that in response, over time, companies that value these attributes would have drifted towards an Australian listing and bring investors with them. Imagine an Australian listing for GE, Google and Exxon Mobil.
Or as Australia has done today we could follow the misguided response of the UK and US policy makers and intervene by placing limits on short selling. There is currently a short selling bill before Parliament. Lets hope this knee jerk response doesn't find itself in the black letter law.
Wishing for limits or prohibitions on short selling may appear to improve the situation in the short term, however as Aesop warns, over time it will shrink the number of participants and kill off any aspirations of Australia being a regional player in financial services.
The decision by ASIC to follow suit with a harsher response puts in jeopardy the fledgling Australian hedge fund industry. Australian funds that use short sales in Australian securities to manage risk will not able to do from Monday. Should these funds be suspended for the period of the limitation? There is a strong argument that they should be closed and monies returned to investors as the funds cannot be managed as specified in their respective product disclosure statements.
Any country that can be brave enough to stand firm in support of free and fair financial markets, while regulators in current leading markets practice their voodoo economics, will have an opportunity to develop a strong financial services industry with a global presence, bringing new jobs and prosperity.
Guest post by Rick Steele