Predatory hedge funds more than tripled the short positions they hold on companies listed on the London Stock Exchange (LSE) last week. Short selling involves ‘borrowing’ the shares of a company from their owner in the belief their value will drop. The shorter sells the shares after borrowing them and then buys them back at a, hopefully, lower price before returning them to their original owner and pocketing the difference. If a company’s stock is being heavily shorted, the practise can drag share prices down further by alarming traditional ‘long’ investors.
Shorting activity, in the majority carried out by hedge funds, has reached its highest levels since records began a little over 7 years ago, according to Financial Conduct Authority data. A number of senior figures have called for a ban on it until the coronavirus storm passes, fearing that it may drag already struggling companies into the abyss.
Andrew Bailey, recently appointed as the Bank of England’s new governor recently pleaded with shorters to cease activity, stating “just stop what you’re doing,” and warning it is not in the interest of Britain’s economy or its people.
Source: The Times
Prior to the onset of the bear market sparked by the Covid-19 pandemic, the FCA was logging an average of 32 short declarations a day. Last week that had jumped to well over 100. The weekly average has spiralled from 159 short declarations to 526 by the middle of last week.
New regulations introduced in 2012 oblige short sellers to report any positions that grow to more than 0.5% of the shorted company’s issued shares. After that declaration has been made, short sellers must provide updates on any lifting or lowering of their position.
The FCA has refused to rule out a complete ban on short-selling but said that it has set a high bar for doing so. The regulator is reluctant to interfere in normal market mechanisms unless it feels it is left with little choice to prevent a markets meltdown. Under normal circumstances, short selling is considered a valuable check on over-priced shares, highlighting potential issues other investors may not have spotted.
Roger Barker, head of corporate governance at the Institute of Directors, cautioned:
“Short-selling is an important check and balance in a healthy market. However, these are not normal times, and this is not a healthy market.
“The government has said it will do whatever it takes to keep business afloat, and clamping down on short-selling may well be another tool in the armoury. More broadly, as a temporary measure it could reduce market volatility.”
Several European regulators, including those in France, Spain, Italy and Belgium have already announced temporary bans on short-selling. The FCA does have precedent in following a similar route, having imposed a ban on London-listed banking stocks in the autumn of 2008, at the height of the international financial crisis.
However, not everyone believes a ban on shorting should be activated. Russ Mould, investment director at online stockbroker and investment platform AJ Bell warned:
“Some countries have tried to ban shorting, to help maintain market order or on moral grounds, although this never really helps. If a share price is going to go down it will do so, whether fund managers can short it or not.”
Researchers at City University London’s Cass Business School and the University of Naples Federico II, published a 2017 academic paper that suggests Mr Mould may have a point. The study found that banning the shorting of certain stocks during the international financial crisis and then eurozone debt crisis actually increased the probability of default and volatility compared to stocks left to the mercy of the market.