Global consternation over short-selling ban

A group of the world's biggest hedge funds are planning to sue the Financial Services Authority for millions of pounds of losses incurred as a result of the regulator's ban on short-selling last week. Lawyers are being galvanised on behalf of a raft of hedge funds which claim the financial watchdog has illegitimately extended its powers and caused "wide-spread capital destruction."

One said: "The FSA's remit is to maintain orderly markets - the markets were working fine, only the banks were going bust. With one swoop, the regulators have wiped out perfectly legitimate businesses and have cost some funds millions. They have gone for the big political hit without a thought for the damage they are wreaking. There may be unintended consequences but it's outrageous and illegal."

The backlash follows a week in which the multi-billion pound hedge fund industry has been plunged into crisis. Prime brokers in London estimated that 35 per cent of European hedge funds were organising emergency measures to avoid closing funds as a ban on short-selling has hamstrung managers at a time when they need flexibility to survive.

Meanwhile the U.S. hedge-fund industry's biggest lobbying group urged regulators to revise new rules that crack down on short selling, saying the measures unfairly blame traders for the financial crisis.

The Securities and Exchange Commission should scrap plans to make hedge funds publicly reveal new short positions and instead require private disclosure, the Washington-based Managed Funds Association said in a recent letter to the SEC. A temporary ban on bets that financial stocks will fall should be adjusted to permit hedging, the MFA added. Markets are “undergoing an extremely stressful period”, because of “poor lending, risk management and disclosure decisions, made historically by many financial institutions, and not from short-selling activities”, MFA President Richard Baker said in the letter.

The SEC passed its emergency rules last week after a global market rout threatened the survival of financial companies. The measures forced hedge funds to reveal short positions and barred investors from betting on stock-price declines at 799 banks, insurers and securities firms.

Managers are furious that the regulators have not taken time to introduce more targeted measures. One said: "Short-selling is used for a raft of reasons, not just betting on stocks going down. Sure, there are some evil market manipulators, but this ban has trashed legitimate businesses from options trading, convertible funds and a range of risk management strategies."

Another said: "It's too easy to blame hedge funds. The real culprits are the banks which were cavalier in their lending, and the investment banks which were irresponsible in the way they packaged the loans and pumped them round the world. It's also the regulator's fault for not picking it up, not ours."

Locally, ASIC followed suit in a series of contradictory announcements, deciding on 22 September that both naked and covered short selling would be banned (the latter subject to limited authorised market-maker exemption) for a period of 30 days after which it will assess whether to reopen covered short sales for non-financial stocks.

In announcing the decision, Mr Tony D’Aloisio said "These measures are necessary to maintain fair and orderly markets in these exceptional times of global crises of confidence in financial markets. Because of the relatively small size and the structure of the Australian market, it is necessary to extend the prohibition to all stocks. To limit the prohibition to financial stocks, as has been done in the UK, could subject our other stocks to unwarranted attack given the unknown amount of global money which may be looking for short sell plays".

However, VanMac Group Managing Director Scott MacDonald believes the ban on short selling has been done to shore up market confidence as a potential cause of the recent extreme volatility.

“It will be interesting to see if this action of quarantining short selling will eliminate short selling as a major factor in the recent huge market gyrations.”

“But the feeling among experts is that this decision is probably more about market perception and may end up causing more harm than good.”

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