Bloomberg News

Shorting Bans Do Little to Help Europe Banks, Instinet Says

October 03, 2011

(Adds information from Credit Suisse study in paragraph after ‘2008 Bans’ subhead and in third paragraph from end.)

Oct. 3 (Bloomberg) -- Financial stocks subject to rules restricting short sales in France, Italy, Belgium and Spain have behaved about the same as banks in European countries with no such prohibitions, according to Instinet Inc.

French lenders governed by the regulations trailed the benchmark CAC 40 Index by about 7 percentage points between Aug. 12, when the ban was imposed, and Aug. 29, data compiled by the New York-based brokerage show. Italian financial firms fell about 4 points more than the FTSE MIB Index, the data show. Shares in the U.K. and Netherlands, which didn’t ban bearish bets, underperformed by 5 or 6 percentage points, Instinet said.

The study says prohibiting bearish bets did little to stem volatility or reverse losses after concern about the European debt crisis sent banks in the Stoxx Europe 600 down more than 30 percent from their February highs. France banned short sales in companies such as Societe Generale SA and BNP Paribas SA, and Italy’s rules covered almost 30 companies such as UniCredit SpA.

“The short-sale bans didn’t protect stocks in terms of price or volatility and were a negative for market quality,” Alison Crosthwait, managing director for global market structure research at Instinet and author of the report, said in an interview. “The stocks performed the same as counterparts without a ban. It didn’t help them not fall or prevent losses.”

Similar Outcomes

Short sellers sell borrowed securities, hoping to buy them later at a lower price and return them to the lender. The tactic can be used to bet on a stock decline or hedge a position, or as part of a trading strategy involving multiple securities. Market makers also sell stocks short as part of their normal trading.

While financial companies in France and Italy fared worse than benchmark gauges in those countries, lenders in Spain and Belgium did better. German financial stocks, which had no short- sale restriction, also beat the DAX Index. Similar results in countries with bans and without suggest no effect attributable to the curbs, Crosthwait said.

The 46-member Bloomberg Europe Banks and Financial Services Index dropped 4.2 percent compared with a loss of 0.5 percent for the Bloomberg European 500 the period from Aug. 12 to Aug. 29. Stocks with bans on short selling, including BNP Paribas and Banco Santander SA, are among companies in the gauge.

2008 Bans

A report on the short-sale ban from Credit Suisse Group AG said banned financial stocks fell 10.4 percent from Aug. 12 to Sept. 20, while German, Dutch and British constituents of the MSCI Europe Financials Index declined 4.4 percent. The study, published today, says the rules didn’t stop share price declines in affected European stocks. Analysts Mark Buchanan, Jonathan Tse and Drew Vincent, based in London, wrote the report.

Crosthwait said Instinet’s conclusions echo academic studies that found bans on short sales of bank and financial stocks instituted in the U.S., U.K. and elsewhere in 2008 didn’t lessen volatility or prevent declines in the shares of companies such as Morgan Stanley and Goldman Sachs Group Inc. With a ban in place, price declines come from holders of the stock selling shares to cut losses, raise capital or adjust their holdings.

The U.S. Securities and Exchange Commission implemented a ban on about 800 financial stocks in September 2008 after bank executives including John Mack, then chief executive officer of New York-based Morgan Stanley, said short sellers were driving down prices in the aftermath of Lehman Brothers Holdings Inc. filing for bankruptcy. More firms were later added. The U.K.’s Financial Services Authority and other regulators also prohibited short sales of financial shares.

Financial Stocks

British financial stocks dropped 41 percent in the four months after the FSA imposed the ban that September. The benchmark FTSE 100 Index fell 15 percent in the period. When the SEC prohibited short-sales for three weeks, a Bloomberg Index tracking the 880 U.S. stocks affected fell 26 percent, outpacing the Standard & Poor’s 500 Index’s 22 percent decline.

The European Securities and Markets Authority coordinated the August bans on short sales. ESMA, established last year, succeeded the Committee of European Securities Regulators.

Regulators used the bans “to shock and awe the markets and reassure investors that markets were not manipulated,” James Clunie, investment director for U.K. equities at Scottish Widows Investment Partnership, the Edinburgh-based fund unit of Lloyds Banking Group Plc, said in a phone interview. “It was viewed as shocking when it was originally done, but when repeated a few years later it’s less shocking.”

The curbs reduced liquidity for investors and made it harder for traders to hedge positions, according to Clunie. He questioned the need of regulators to try to stabilize prices.

‘Extremely Negative’

“If people felt extremely negative about European banking shares, there might be a knock-on influence if they shorted bank shares in other countries,” Clunie said. “We’re not seeing knock-on effects coming into the U.K. market.” He added that it may be difficult to assess the fair value of banks because they’re “so leveraged,” making shorting them riskier.

The Instinet study examined three time periods including a base interval from July 21 to Aug. 2, when Europe’s VStoxx Index, which measures the cost of protecting against a decline in the Euro Stoxx 50 Index, averaged 25.9, according to Bloomberg data. That was followed by a period from Aug. 3 to Aug. 11 when the VStoxx Index surged to 41.9. The third span, from Aug. 12 to Aug. 29, tracked activity when the ban was in effect. The volatility index rose to 42.8 in that period.

Instinet compared activity in nations with bans to trading in the U.K., Germany, the Netherlands, Switzerland, Sweden, the U.S. and Canada. Instinet is owned by Tokyo-based Nomura Holdings Inc.

Daily Moves

The average daily price moves of financial stocks decreased during the ban period compared to the early August span by more than 60 percent in France, more than 40 percent in Italy and over 30 percent in Spain, Instinet data showed. The reduction in volatility was similar in countries with no bans. Germany, the Netherlands and the U.S. recorded average daily absolute price changes in financial stocks during the ban period that were less than half the size of the moves in early August, Instinet said.

“If the short-sale bans succeeded in reducing volatility, one would expect the reduction of price volatility to be greater in countries with the ban than without,” the Instinet report said. “In fact, the reduction in volatility between the two groups is similar.”

While the average bid-offer spread, or the difference between the highest price at which investors will buy shares and the lowest at which they’ll sell, increased for banned and non- banned financial stocks as volatility rose in August, it then diverged for the two sets of companies, Credit Suisse research showed. Stocks with bans recorded bigger increases in spreads than those in the German, Dutch and British components of the MSCI Europe Financials Index through Sept. 16, the broker said.

Volume Impact

The bans also affected volume. Trading in financial companies in Italy and Spain plunged by more than half in the Aug. 12 to Aug. 29 period, compared with the span from July 21 to Aug. 2 before volatility increased, Instinet data showed. It shrank by more than a quarter in France and Belgium while volume in countries with no bans rose.

“If you can’t short, you can’t hedge,” Clunie said. “It throws sand in the machinery of some market players. But if there were manipulated stocks, it throws sand in their machinery too and reassures investors.”

--With assistance from Howard Mustoe in London, Stephen Kleege in New York and Jesse Westbrook in London. Editors: Chris Nagi, Joanna Ossinger

To contact the reporter on this story: Nina Mehta in New York at nmehta24@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net


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