Widespread doubts that ‘ban’ has reduced volatility

A month ago the Australian Federal Government bowed to pressure from leading company executives and banned short selling. As reported in the AFR on 21 October, the move was designed to restore confidence in the sharemarket and stop the selling attack by hedge funds on certain stocks such as Macquarie Group, Babcock and Brown, Leighton Holdings, ANZ Banking Group and Rio Tinto.

The AFR reported Credit Suisse equities analyst Adnan Kucukalic as saying that “after the beginning of the ban on short selling the market continued to sell off in a very, very aggressive fashion. The biggest sell-off was during the time when short selling was actually banned.”

The negative market performance since the ban was introduced indicates that hedge funds and short sellers may have been unfairly demonised and blamed for the wild price swings in the market.

But the ban has not stopped the massive sell-off and analysts doubt whether it has helped reduce volatility in the market, as many stocks continue to reach new lows; some experts, including VanMac Group’s Managing Director Scott MacDonald, have even said that the ban has made no beneficial difference to the market.

“It seems to have had the opposite effect on volatility,” he comments. “There now appears to be less liquidity in equity markets, yet they have become more volatile. Perhaps we need to look elsewhere for the cause of the volatility and allow short selling up to a pre-determined level.”

In the same article Eley Griffiths director and portfolio manager Ben Griffiths argued that the price action had shown that long-only players can be just as destructive.

Throwing further doubt on any positive outcomes of the ban is that the Australian market fell further than its global peers during the same period.

Market watchers believe the ban on short selling, which has been tipped to be extended, should be modified so that more disclosure would ensure the market was not distorted. Adnan Kucukalic believes that regulators needed to thwart the ability of funds that gang up on a stock and create a massive amount of pressure on its price. And other pundits and hedge fund managers are shaking their heads in disbelieve at the naivety of the financial regulators.

Mr MacDonald agrees, adding that short selling is clearly not the cause of the financial crisis nor is it the activities of hedge funds more broadly – it is clear that unlike previous financial crises, such as Asia 1998, hedge funds can no longer be the scapegoats for systemic incompetence, poor business management and the greed of a few arrogant ‘Wall Street’ types that have rocked the global financial system to the core.