Shorting returns

So will the expiry of the ban lead to a sudden rout of this maligned group of shares as short sellers gang up on them? It’s tempting to think so. After all on 18th September 2008, the day that the ban was introduced, shares in the banking sector rose by 21 per cent. Some analysts are expecting a severe reversal when the ban is lifted as the hedge funds get to work again.

I’m not so sure though. As Mr Bearbull points out this week (see page 17), the ban did nothing to protect the value of financial shares while it was in force – the banking sector has fallen by 32 per cent since 18th September. The scale of the industry’s collapse more than outweighed the impact (if any) of the ban on short selling.

And the end of the ban will also have its advantages. One of the benefits of the recent growth in instruments such as spread betting, contracts for difference and covered warrants is that private investors are now on a level playing field with the hedge funds when it comes to having the ability to go short. Individuals now have the freedom to either speculate that prices will fall or to hedge existing long positions in a certain share or sector. The FSA’s ban deprived investors of the ability to protect their portfolios precisely at the time when they needed it most.

The ban also reduced liquidity. According to research from the London Stock Exchange, spreads in those shares covered by the ban have widened by 150 per cent more than spreads in a control sample of other shares. And turnover in those shares has fallen by 21 per cent since the ban was introduced, against a 42 per cent increase in turnover in the control sample.

So the end to the ban is welcome, despite the fears of many who have invested in the sector. Just as it failed to protect share prices when it was in force, it is unlikely to damage prices when it is repealed. That said, the FSA’s extension of disclosure requirements for short sellers is also to be welcomed. Despite the howls of protest from some in the hedge fund industry, a more transparent market is a more efficient one. Better disclosure of short positions will surely help that transparency.