This move by Spanish and Italian regulators was widely expected, as many others have used similar bans in recent years, hoping to stabilise volatile markets or support plunging stock prices. Unfortunately, bans on short selling don’t seem to do either, at least not for long. Apart from some hard-to-verify bounces on the announcement, prices of stocks supposedly protected by the ban continue to move in line with how they would have without the ban. Why? Because short sellers aren’t really driving the market. It is news about the condition of companies and economies that pushes prices around. If banning short sellers were costless, this lack of effect would not be a problem. But bans are costly. By reducing liquidity they increase the cost of trading for everyone in the market, whether a buyer or a seller. And lower trading volumes make it harder for markets to do their key job of pricing assets accurately.
Ian Marsh is professor of finance at Cass Business School.
Short selling in the marketplace is crucial for price discovery. Stop this and you cut off the flow of information on a stock or, in this case, hundreds of stocks and their derivatives. Short selling bans are the equivalent of a used car garage, with a reputation for selling faulty cars, announcing that customers can no longer look under the bonnet of cars on the forecourt. Bereft of information, customers err on the side of caution and assume that all cars on the forecourt are lemons. However, we have seen in the past that short selling bans are ineffective – investors roll over net short equity index derivatives and therefore maintain their short positions. To labour further with the used car example, Italian and Spanish financials have nothing going through the fuel line. And customers are aware of this. Stopping the market from getting under the bonnet is not going to return market confidence and prices will continue to slide.
Craig Drake is financial features writer at City A.M.