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Short selling bans sweep Europe, but could have unintended consequences

Regulators in Italy, France and Spain have put short selling bans in place in a bid to ease market turmoil amid the coronavirus, but, if past experience is anything to go by, they may do more harm than good.

European regulators put similar bans in place during the global financial crisis and European sovereign debt crisis, and were especially anxious to prevent bank stock crashes as this could lead to funding problems.

Short selling, or shorting, is when an investor borrows shares in a company it believes will decrease in value, sells them with a view to buying them back at a lower price, then returns them.

Amid the latest COVID-19 crisis and the accompanying falling share prices, authorities around Europe have acted to curb the practice.

Consob, the Italian regulator, called a three-month ban on shorting of all shares starting from March 18. In France, regulators called a month-long ban on shorting on March 17, as did the Spanish regulators, which said their ban could be extended for three months if necessary. Austria also banned short selling in order to maintain the stability of financial markets.

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Consob's measures follow narrow one-day bans on the short selling of certain stocks — including banks UniCredit SpA, Banca Generali SpA, Unione di Banche Italiane SpA, Mediobanca - Banca di Credito Finanziario SpA, Banca Mediolanum SpA, and Banca Monte dei Paschi di Siena SpA, along with special servicer doValue SpA and credit manager Cerved Group SpA — earlier in March as coronavirus fears gripped the market.

The move by France similarly extends an earlier narrower ban on stocks including AXA SA, BNP Paribas SA, Crédit Agricole Group and Natixis.

Meanwhile pan-Europe regulator the European Securities and Markets Authority lowered the threshold for short position holdings to improve transparency. Senior European lawmaker Markus Ferber has suggested a pan-European ban on short selling might be necessary, Reuters reported March 18.

Clues from crises past

Dr. Daniela Fabbri, reader in finance at Cass Business School, says that shorting bans in past crises have not helped.

In the 2007/2008 crisis, bans were put in place with a particular view to preventing collapses in the price of bank stocks, as these could lead to funding problems, which would in turn lead to further drops in the share price, Fabbri said in an email.

But contrary to regulators' intentions, she said in an email, "there is evidence that banned financial institutions displayed even larger share price drops, greater return volatility, and higher probability of default; these effects were particularly strongly felt with more vulnerable banks during the 2007/08 crisis."

Fabbri also noted there are important differences between the global financial crisis and the coronavirus situation, with the latter being more about the impact on the overall economy.

There may be a political element behind the decision, with regulators anxious to demonstrate that they are addressing the situation, she said.

Marco Pagano, professor at University of Naples Federico II and fellow at the Einaudi Institute for Economics and Finance in Rome, calls shorting bans a "Pavlovian" response to bad news by regulators.

Pagano, who has previously carried out research on shorting bans during the global financial crisis, says the historical evidence for their effectiveness is not encouraging.

He analyzed daily data on 16,491 shares in 30 countries between January 2008 and June 2009 for a paper published in The Journal of Finance in 2013.

"Our results indicate that the short-selling bans implemented over those months did not go hand in hand with increases or lower drops in the prices of exchange, except in the U.S. in the two weeks following the application of the ban — an exception probably due to the simultaneous announcement of bank bailouts by the U.S. government," he wrote in a March 17 blog post.

Nevertheless, it is likely Europe will see more shorting bans in the coming weeks and months, Pagano said in an email.

Reduced liquidity

Gemma Godfrey, editor at financial advice website Times Money Mentor and founder of the former robo advice business Moo.la, warned that bans could hinder the effective functioning of markets.

"The concern is that by reducing the number of trades, you reduce liquidity in the market," she said in an interview.

Less trading means that it is also difficult to get accurate price discovery, she added.

Moo.la was acquired by Marsh & McLennan Cos. Inc. company Jardine Lloyd Thompson in 2018.