Short-selling ban reveals divisions within Europe

A piecemeal ban on short-selling of financial stocks in Europe sparked a rush of alternative proposals from countries and regulators on Friday, while stronger bank shares pulled Europe’s stocks higher.

After a week of wild swings on European markets on rumours about the health and funding needs of indebted governments and some of their major banks, France, Italy, Spain and Belgium imposed short-selling bans, which varied according to country.

Britain, The Netherlands and Austria said they saw no need for action, while Germany said it would instead push for a Europe-wide ban on so-called naked short-selling.

The European Commission said a European framework would be more effective, and the chairperson of the European Securities and Markets Authority urged policy makers to adopt a plan for bloc-wide rules on short selling “as quickly as possible”.

Short-selling is the process through which an investor borrows shares and sells them on the expectation their price will fall and they can be bought back at a lower price.

The game of chicken
In a naked short sale, the investor has not borrowed the share, but still bets on a drop in the share price.

Market players said the ban did not tackle the root causes of investors’ concerns — joined-up, long-term fiscal policy in the eurozone — and pointed out that nervous mutual funds were currently behind the sell-off.

“If at the core of this whole rout is disappointment with certain irresponsible behaviours of policymakers — note the game of chicken in the US — they really need to get their act together and prove they aren’t all on holiday,” said Lothar Mental, chief investment officer at Octopus Investments.

A crackdown on speculative short-selling is unlikely to arrest moves from institutional investors who now have little stomach for big holdings in banks and indebted governments who might call on them again for emergency capital.

The STOXX Europe 600 banking index rose 4.5%, helping the broader market up 3.7%.

Rescue for the eurozone?
French banks, at the centre of attention and included in the ban on short-selling, were up: Société Générale rose 5.7%, BNP Paribas added 4.2% and Crédit Agricole gained 2.1%.

Alessandro Frigerio, fund manager at Milan’s RMJ Sgr, said the ban could work if, combined with proposals from next Tuesday’s meeting of French President Nicholas Sarkozy and German Chancellor Angela Merkel, it were to “give the idea that there could be a rescue for the eurozone”.

But global hedge fund association the Alternative Investment Management Association warned the short-selling bans could make markets less stable.

“Past experience has shown that bans on short selling do not prevent market falls and indeed can exacerbate volatility,” association chief executive Andrew Baker said in a statement.

“Short-selling … contributes to efficient price discovery, increases market liquidity, facilitates hedging and other risk management activities and can possibly help mitigate market bubbles,” he said.

US trades sometimes possible
Investors can sometimes avoid the ban by trading some on other markets — US listed shares of European institutions that cannot be sold short there can still be shorted in the United States, a New York Stock Exchange spokesperson said.

That includes Spain’s Banco Santander SA, whose ADRs are traded on the Over the Counter Bulletin Board, or Pink Sheets, and can be sold short, a spokesperson for OTCBB said.

But the largest European banks in question, including Société Générale, are not listed on major US exchanges such as the NYSE and Nasdaq.

“It’s only in those countries where the short-selling is no longer being allowed, where you might see increased relative short-selling of the ADR,” said Bryant Evans, investment adviser and portfolio manager at Cozad Asset Management, in Champaign, Illinois.

‘Abusive’ strategy
A German banking source familiar with regulation issues said the European Securities and Markets Authority (ESMA) had failed to play its role as coordinator among European Union countries when it introduced the ban, arguing that short-selling combined with rumour-mongering to create a strategy that was “clearly abusive”.

EMSA chairperson Steven Maijoor said there were no concrete plans at this stage for other countries, but he could not rule out the possibility that that could change.

“What kind of coordination has the ESMA delivered? Not much,” the German source said, describing Britain as the main obstacle to a coordinated move against short-sellers due to fears such a ban would hurt its financial sector.

Britain temporarily banned short-selling of financial stocks in 2008, in line with a US ban imposed four days after the collapse of Lehman Brothers ushered in a dangerous new phase of the financial crisis.

Academic studies show US share borrowing fell during the three-week ban, but financial stocks continued to plummet.

In the latest action, France banned short-selling on 11 financial stocks for 15 days, Spain said it would protect 16 stocks for 15 days, Belgium banned short-selling of four financial stocks for an indefinite period and Italy said its ban covered 29 companies in the banking and insurance sector.

‘Destructive speculation’
French Finance Minister Francois Baroin welcomed the ban and said it highlighted the government’s commitment to ensuring financial stability, avoiding market abuses and fighting against all forms of speculation.

French 10-year bond yields dipped below 3% on Friday for the first time since November, showing demand for French debt remained intact despite banking sector concerns.

Reassuring data from the European Central Bank helped: the ECB said its overnight loan facility totalled €227-million, down from the €4-billion borrowed the previous night, easing fears that banks were facing liquidity issues.

However, Danish Economics Minister Brian Mikkelsen said several small Danish banks are facing a liquidity squeeze and the government was working on measures to make it safe for foreign investors to lend to them.

France and Italy also plan action against investors who combined rumour-mongering and short-selling to manipulate banking shares. The French Banking Federation said French banks were considering legal action, while Italy’s Consob said it would fine those who disregarded the short-selling ban.

Germany called for wide-reaching ban on naked short-selling.

“We are advocating a wide-reaching ban on naked short-selling of stocks, sovereign bonds, and credit default swaps,” Finance Ministry spokesperson Martin Kotthaus said. “Only this way can destructive speculation be countered convincingly.” — Reuters

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