Short selling crucial for mitigating ESG risks, says AIMA report

Recent study from hedge fund group AIMA outlines how short selling is an important tool for responsible investing, and for investors to hedge against ESG risks.

Short selling has become an essential tool for environmental, social, and governance (ESG) investing strategies and is crucial in protecting investors from ESG risks, according to a new report. 

The report, from the Alternative Investment Management Association (AIMA) and law firm Simmons & Simmons, outlined that short selling is key for responsible investing as campaigns are often triggered based on ESG concerns.

Hedge fund strategies can also provide greater insights into how long and short portfolios are exposed to certain risks like climate change and carbon exposure. The report added that short selling is crucial in allowing investors to hedge against ESG risks.

“Alternative investment managers have always been at the forefront of investment innovation. Today, they are using one of their defining abilities – short selling – to protect their investors from novel risks, and to make markets as a whole safer,” said AIMA CEO, Jack Inglis. “We are happy to see this fact gain increasing recognition from investors and leading organisations such as the PRI, and we have no doubt that short selling will soon be seen not just as valuable for responsible investment, but essential.”

The recent report from hedge fund association AIMA follows a widespread ban on short selling across Europe at the height of the market volatility amid the coronavirus pandemic. Not long after the bans were implemented, multiple trade groups and associations, including AIMA, urged the restrictions be lifted as they had failed to curb the volatility, harmed liquidity and price formation, and increased trading costs. The short selling bans were eventually lifted in mid-May.

Short selling, considered a risky but lucrative trading strategy mostly applied by hedge funds, is a bet that the price of a stock will fall. Short sellers borrow shares and immediately sell them, betting the price will fall before they buy back the shares and return them to the lender, pocketing the margin.

“Banning short-selling interferes with price formation, thereby increasing uncertainty. That can only artificially amplify volatility and probability of default, the opposite effect to that claimed and hampers the ability of markets to serve the real economy,” said Nandini Sukumar, CEO of World Federation of Exchanges in a statement at the time of the ban. “It is not – and never has been – true that bans have any other, positive effect on market activity or price levels.”