Long-Only Investors Jump to Defense of Shorters

Terry Flanagan

Short selling is maybe viewed by many traditional long-only investors in Europe as a necessary evil—much like how many on the buy side see high-frequency trading—but for something that is so unloved, there are many asset managers in the region quick to jump to its defense.

“Shorting is a dark art maybe but it is actually quite a valuable art,” said Andrew Parry, chief executive of Hermes Sourcecap, a U.K.-based asset management firm.

Short selling has come under much scrutiny from politicians and regulators alike in Europe in recent times. Several eurozone countries have imposed temporary short-selling bans amid the sovereign debt crisis, while many countries, including the U.S. and U.K., put in place a range of restrictions on the short selling of listed securities following the collapse of U.S. investment bank Lehman Brothers in the midst of the credit crisis in 2008.

And last November, the European Union introduced new short-selling rules, which are intended to create a level playing field across the region, but which have left many market practitioners unprepared and confused for the tough new disclosure requirements for shorters.

Investors now have to disclose short positions and settle their short trades in four days, down from 30 days at present. Although exemptions were made for market makers and primary dealers. Rules on ‘naked’ short-selling, the process of selling shares that you have not even borrowed, were also tightened.

“The actual volume of transactions of shorters in the market compared to the long term natural buyers in the market totally overwhelm the shorts,” said Parry.

“Shorting is a much harder thing to do and generally very few short transactions make significant amounts of money, so again it provides liquidity. And if you take liquidity out of the equation, you get more volatile markets. I do believe that throwing grit into the system doesn’t help. If anything, it raises the danger of increased volatility.”

The European Securities and Markets Authority, the pan-European regulator, is currently in the process of receiving feedback from the industry on the new short selling rules as it prepares to write technical advice to the European Commission on the evaluation of the effects of the rules, which have been in operation now for nearly six months.

“I don’t mind it and I am probably glad it exists but it is not something that is built into our portfolios,” said Toby Ricketts, chief executive of Margetts Fund Management, a U.K. investment boutique which specializes in managing risk rated multi-manager funds.

“It’s like high-frequency trading, it does provide liquidity to the market and hopefully makes them more efficient. But it is an entirely different style of investing to ours.

“When you buy a stock on a long-only position, you have the freehold and it doesn’t cost you to own it. You are not paying for time. But when you short a transaction, that always has to be renewed so time costs money to rent the position.”

The temporary short-selling bans imposed by many European nations in times of recent economic stress have provoked anger from many in the industry as they believe that it will put the brakes on securities lending activity and be harmful to liquidity in general, as well as hampering market making activities, which will in turn increase spreads.

“One of the reasons typically given for introducing a ban on short selling is that such a move will combat volatility in the market,” Dr Christian Voigt, business solutions architect at trading and technology company Fidessa, told Markets Media last October.

“However, a number of studies have suggested that this assumption is flawed, and that a ban on short-selling is not a tried and tested method for stabilizing share and bond prices.

“Studies have also concluded that short-selling bans can be detrimental for liquidity especially for stocks with small capitalization and no listed options; it can slow price discovery, especially in bear markets, and fail to support prices.”

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