Short selling is a trading strategy fund managers employ when they believe that shares of a particular stock are overpriced. It generally means borrowing a security (or commodity futures contract) from a broker and selling it, with the understanding that it must later be bought back (hopefully at a lower price) and returned to the broker. Short selling is a technique used by investors who try to profit from the falling price of a stock.
Short selling is an essential risk management tool and a critical component of ensuring market stability. It plays an integral role in the proper functioning of markets, as it contributes to efficient price discovery, increases market liquidity, and promotes capital formation, among other benefits. It also allows investors to hedge other positions and to facilitate capital formation.
In the wake of the economic downturn, some were eager to blame short selling for driving down the price of securities, and the Securities and Exchange Commission (SEC) along with regulators in other countries, instituted a temporary ban on the use of short selling in 2008.
MFA contends that restricting short selling has not been shown to provide an ultimate benefit to the stock it is meant to protect. In fact, when the first emergency order was enacted in July 2008 and later extended, the stock prices of the 19 financial sector securities went up initially, but by the time the order expired, the majority of those securities had declined in value during the time of the order. SEC Chairman Cox subsequently stated that imposing the ban was the biggest mistake of his chairmanship.
More recently, several European countries have imposed emergency bans on short selling of some stocks. MFA opposes this more recent effort and believes it will not have the desired effect of stabilizing prices. Moreover, by implementing these bans without a public consultation period, investors were not able to adjust their portfolios in advance to accommodate the ban and were left trying to comply with the bans with little information about how they applied in many circumstances. MFA respectfully believes that such actions do not enhance investor confidence.
MFA supports other, more effective means to regulate short selling responsibly. For example, MFA has supported Regulation SHO with its close out and locate requirements, to prevent abusive practices. MFA also has supported other market reforms, such as modernizing circuit breakers and “limit up/limit down” requirements.
It also is important to remember that short selling is not the same thing as market manipulation. MFA depends on honest markets that operate on the basis of supply and demand, not fraud. MFA abhors any effort to manipulate markets – whether by long or short sales. MFA supports vigorous enforcement efforts against those who seek to manipulate markets.
Click here for MFA’s Resource Guide: EU Short Selling Regulation.
Click here for more information on current EU short sale restrictions.
Learn more about short selling with MFA’s educational presentation, Short Selling: A Brief Overview and Regulatory Update.
MFA Comment Letters to European Policy Makers and Market Authorities on Short Sale Restrictions: MFA submitted letters to: France’s AMF and Ministry of Finance; Italy’s Consob and Ministry of Finance; Spain’s CNMV and Ministry of Finance; Belgium’s FSMA and Ministry of Finance; Germany’s BaFin and Ministry of Finance; European Securities and Markets Authority; European Council; European Central Bank; EC Commission Michel Barnier; and EC Commissioner Olli Rehn.