A review of academic research shows that it “almost unanimously” points towards short-selling bans being disruptive for the orderly functioning of markets.
The WFE (World Federation of Exchanges) has published a new paper that reviews the academic literature in favour and against short-selling bans.
In its review, the WFE found that the academic evidence almost unanimously points towards short-selling bans being disruptive for the orderly functioning of markets – as they are found to reduce liquidity, increase price inefficiency, hamper price discovery and have negative spillover effects in other markets.
In addition, the evidence suggests that banning short-selling during periods of heightened uncertainty seems to exacerbate, rather than contain, market volatility.
According to the literature, during periods of price decline and heightened volatility, short-sellers do not behave differently from any other traders, and contribute less to price declines than regular ‘long’ sellers.
As research has shown that short-selling bans are more deleterious to markets characterised by a relatively high amount of small stocks, low levels of fragmentation, and fewer alternatives to short-selling, emerging markets should be particularly wary of bans on short-selling, the WFE says.
“Based on the existing evidence, the WFE recommends that financial regulators do not introduce short-selling bans, as the academic literature demonstrates not only their lack of effectiveness, but their negative impact on market quality,” says WFE chief Nandini Sukumar.
‘We would urge jurisdictions that have imposed such bans to reconsider in the light of the evidence.”
In Asia, South Korea, Malaysia and Indonesia have imposed short-selling bans, while a number of other regulators (Thailand, Taiwan, India) have tightened their rules to make the practice more difficult.
Earlier this month, Austria, Belgium, France, Greece and Spain announced that short-selling bans implemented throughout April would be extended until 18 May, possibly longer.
The paper, available here, follows the WFE’s recent statement where it criticised current bans on short-selling as damaging to markets and failing to achieve their desired effect.
The ISLA (International Securities Lending Association) Council for Sustainable Finance has also recently issued a position paper arguing against the application of short selling bans as a response to the Covid-19 pandemic and related volatility.