Short-sellers are facing new, more onerous restrictions, most notably a potential mandate to disclose their publicly held short positions on a regular and timely basis, called public short-selling disclosure requirements, or SSDRs.
Problem is, no one has yet proven that forcing managers to disclose their short holdings and / or ban them from taking short positions in select securities has any sort of positive impact on market conditions. Last September AllAboutAlpha.com highlighted a particularly compelling study from the Cass Business School in London showing as much.
Indeed, according to a study published this month by Oliver Wyman, the impact is negative, particularly as managers refrain from actively shorting various securities and markets. The study, entitled, “The effects of short-selling public disclosure regimes on equity markets,” can be downloaded from the Managed Funds Association’s Web site here.
Ganging up on short-sellers in nothing new, particularly in times of market duress. Amid the multiple-billion-dollar bailouts and government rescue plans of mid-September 2008, regulators in the US, the UK and a dozen other countries pulled out the bazookas, issuing outright bans on short-selling of financial stocks and other securities with very limited effect, as the chart from the Oliver Wyman study below shows.
Like any unprovoked blow, the first wave of shock following the 2008 bans quickly turned to anger and defiance, followed shortly thereafter by promises of retribution. Most agreed at the time that the swift yanking of the short-sale plug and more broadly the collective glare the hedge fund industry endured as the culprit behind the reason for the bans in the first place was, to say the least, unfair and unwarranted.
The phrase du jour back then was “moral hazard.”
Needless to say, the dust settled. But now, a year and a half on and with regulators once again talking about imposing both limits and reporting requirements on short-selling, the question of how effective SSDRs are has come back to the fore.
The answer, according to the Oliver Wyman report, is not very. In addition to reducing liquidity, the information to be disclosed by investors is “sufficiently sensitive that they limit their activities to avoid making disclosures.”
The report examines a wide variety of indicators of market health as it tries to determine how disclosure of short positions affects market mechanics. For example, the study found that average daily volumes fell from (pre-ban) levels for stocks requiring short-selling disclosure (“test group” consists of stocks falling under new disclosure rules)…
In addition, average bid-ask spread jumped for stocks in the “test group” (those facing the new disclosure rules) after the disclosure rules were implemented.
In response to falling volumes and rising spreads, hypothesizes the report, intraday volatility rose for stocks falling under the disclosure rules…
In other words, put enough speed bumps on the road and eventually people will get out of their cars and walk.
Or pick a different route. The report also notes that SSDRs would likely encourage investors to move into equity markets with “more palatable regulatory frameworks” – read: less developed markets with less oversight and protections and more latitude.
The notion that market participants in general could choose a less-onerous path certainly isn’t specific to the hedge fund industry. The response to a lengthy SEC “concept document” on equity market structure released earlier this month has, to put it mildly, been less than enthusiastic.
That hedge funds are facing social and political backlash related to recent historical market moves isn’t surprising. After all, it was only 12 years ago that a now-infamous hedge fund brought on the last systemic financial system maelstrom and officially became a not-so-nice acronym for what happens when extreme bets go wrong.
It will be interesting to see who ultimately ends up wearing the shorts once all is said and done: regulators & policymakers or managers & investors…or just a goofy-looking Chihuahua looking for his next meal.