Responses to a consultation on short selling held by the European Commission (EC), the executive body of the European Union, have backed the disclosure of short positions to regulators but warned against public disclosure.
The consultation, which ran from 10-14 June, was given urgent priority by the EC which cited concerns over the effect that shorting might have in periods of economic uncertainty. Short selling has been criticised by a number of European politicians for its potential to exacerbate the falling value of assets.
Numerous national regulators have individually clamped down on the practice during recent market upheavals. Most recently, Germany announced a ban on naked short selling in May 2010. The ban was enacted in an effort to curb speculative trading in the euro-zone, amid fears about the volatility of debt securities and the widening of spreads in credit default swaps due to a perceived increase in government credit default risks. German regulator BaFin suggested that short selling could jeopardise the stability of the European financial system as a whole.
The Commission received 116 responses to the consultation. Respondents gave feedback on the types of instruments that can be shorted, types of short selling activity, reporting of activity and regulatory enforcement.
The vast majority of the responses to the EC consultation defended short selling as a source of liquidity although naked shorting, the practice of short selling without first securing a source for borrowing stock, was decried by a number of firms such as broker CA Cheuvreux.
Harmony was reached on the principle of disclosing of information on short selling, but respondents were virtually unanimous in agreeing that such information should be disclosed only to regulators.
Multilateral trading facility Chi-X Europe questioned the need for regulations to increase transparency. “If policy makers propose a transparency regime for any asset class the market failure should be evidenced and the cost/benefit for the proposals set out. Neither the CESR (Committee of European Securities Regulators) or the Commission's consultations have established this, for shares, or any other asset class.”
It also expressed serious concerns over the effectiveness of the proposed measures. “Marking of orders for short sales would not provide accurate information and would impose substantial additional costs,” the submission noted.
The Managed Funds Association, which represents alternative investment firms globally, supported Chi-X's reservations. “Actual experience with a public disclosure requirement suggests that it may have a negative impact on affected markets in terms of liquidity and bid ask spreads,” the association argued. “ Requiring public disclosure is an unnecessary regulatory action that – however well intended – may cause the very financial instability it is intended to deter.”
The Investment Management Association, the UK-based asset managers' trade body, said that increased transparency is not only unhelpful, but may actually be harmful. “The proposed market disclosure is not necessary to resolve the potential problems identified, and could exacerbate some of the problems, when they do arise,” it said. “Public disclosure of short positions could seriously harm: investment managers…other investors…and the market, by reducing efficient price discovery, increasing volatility and spreads.”
Investment firm Deutsche Bank concurred, arguing that disclosure could increase costs for the entire market.
“Disclosure rules covering equities have been in place in various countries for nearly two years, giving us the time to analyse the effects. The evidence is that public disclosure has a detrimental effect on market liquidity. There are estimates that short sellers are responsible for 20-30% of all equity trading volume,” the bank said. “Research has shown that public disclosure decreases short sellers' participation in equity markets by 20-25%. The decrease in liquidity means a decrease in trading volumes and a widening of bid-ask spreads. Price discovery becomes less efficient and intraday volatility increases.”
Feedback to the consultation will influence the forthcoming EC proposal on short selling, which is scheduled for release for mid-September 2010.