Focus on southern Europe – Short-selling ban to dry up Spanish and Italian markets

The decision by Spanish and Italian authorities this week to reintroduce bans on short selling as markets fell is “an act of desperation” by local governments and will likely drain market liquidity and investor confidence, according to Owen Callan, fixed income and derivatives dealer at Danske Markets.

On July 23, Spain’s Comisión Nacional del Mercado de Valores (CNMV) imposed a three-month ban on short-selling all stocks, while Italy’s Consob blocked short-selling on 29 banks and insurance stocks, for a week.

But market participants say the decisions will hit liquidity in the two markets and could miss the real issues that have caused the surge in Spanish borrowing costs, which over previous days spiked above 7%.

The sell-off seen in the two markets over the last weeks has not been driven by hedge fund speculation, Callan added.

“Authorities have done this before and markets have seen how the mechanism works. Following the ban we have seen a strong shift of short-selling activity towards other markets, in particular towards Germany’s Dax index.

“Most aggressive fund managers have been encouraged to close positions, immediately decreasing liquidity in the two markets,” Callan told Investment Europe.

Callan’s bases his opinion on what happened in times of previous short sale bans, aimed at curbing bets that prices will fall.

In August 2011, market regulators in Spain and Italy, as well as Belgium and France, temporarily restricted some fresh short sales for a specific list of financial stocks.

These attempts have proved not only ineffective, but counter-productive to the final aim.

Callan said, in any case, in the latest cases, “the decision has come too late.

“Most of the money has already left the table over the last months, and Spanish and Italian stocks are at an all time low. Spain is in a much bigger trouble than Italy, and the next policy decision is likely to be announced at EU level, rather than domestic,” he added.

Marco Pagano, professor of economics at the University of Naples Federico II, shared Callan’s concerns and said regulators in both countries have failed to learn lessons of the past.

“Empirical evidence shows that short-selling bans imposed in 2008 after the Lehman Brothers collapse reduced market liquidity, supporting the market only in the very short term,” Pagano said.

It is not the first time the professor has spoken out against the implementation of trading bans.

In a paper published in 2009, just after the decision by at least 14 regulators worldwide to impose bans or regulatory limits on short-selling – as a reaction to the 2007-2009 crisis – Pagano argued bans were detrimental for liquidity, they slowed price discovery especially in bear markets, and they failed to support stock prices, except possibly in the case of US financial stocks.

Empirical evidence has been confirmed by research by US bank JPMorgan, which showed that turnover in shares in major banks of France, Spain, Italy and Belgium during last August’s short-selling ban fell by one quarter.

But most of all, Callan said, the introduction of simultaneous bans in Spain and Italy showed a dangerous sentiment of fear by market authorities, which is likely to lead to a loss of investor’s confidence.

“The move is not smart, and shows a strong sentiment of fear,” Callan said.

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