The naked truth about short-selling

IT HAS now been more than four months since, encouraged by the Federal Government, the Australian Securities and Investments Commission (ASIC) imposed its initial blanket ban on short-selling.

On Wednesday, January 21, and despite widespread industry expectations to the contrary, ASIC decided to extend its ban on covered short-selling until March 6.

By the time the regulator considers the issue again, fund managers will have been denied access to what has traditionally been regarded as a legitimate strategy tool for six months.

When the ban was first introduced it gained the grudging support of many in the financial services industry because they acknowledged that it represented a circuit-breaker at a time of high volatility and consequent uncertainty. What is more, Australia was simply following the lead of other nations, most notably the US and the UK.

The UK lifted its ban in mid-January and, by its own admission, ASIC said that it had decided to do likewise “so as to be in line with other major markets”.

According to the Australian regulator, it backed out of lifting the ban because it had noted an increase in volatility in financial stocks in overseas markets, and it had not had an opportunity to assess whether that volatility was allied to the lifting of the short-selling ban in the UK.

In most circumstances, such caution on the part of a regulator would be laudable, but in the case of the ongoing short-selling ban in Australia it would seem arguable that ASIC is not only delaying the inevitable but also increasing the likelihood that the impact of lifting the ban will be significantly magnified.

What is more, around the same time as ASIC was opting to extend the Australian ban on short-selling, the chairman of the UK’s Financial Services Authority (FSA), Adair Turner, seemed entirely confident that the volatility which had been experienced in the markets was not connected to the lifting of the ban.

“We have no evidence whatever that the lifting of the ban on short-selling has had a significant effect,” he said. “We haven’t seen something that suggests that short-selling and the abuse of short-selling has a significant role in what has occurred.”

Perhaps more importantly, Turner said that if the UK regulator had detected “abusive short-selling” it was prepared to reimpose the ban immediately and without warning.

Given the degree to which the continued ban on short-selling is impacting the workings of the Australian funds management industry, ASIC would do well to adopt the same approach as the UK’s FSA — lift the ban with the clear warning that it will be rapidly reimposed if there is any evidence whatsoever of abusive behaviour.

ASIC has indicated that it is continuing to review its position with respect to short-selling and that there is a possibility it will lift the ban earlier than March 6. On the basis of all the evidence coming out of the UK, it should do so.

It is inevitable that the price of some key Australian stocks will take a hit from the lifting of the ban, but the time has come for the market to be allowed to find its own equilibrium.