Some investors sell shares that they don’t actually hold but borrow under the expectation that prices will fall. If they are right, when they buy back, the stock comes at a cheaper cost than the amount they were paid for those same shares and so sellers can pocket the difference as a profit. A day after the Spanish financial regulator CNMV ruled a full suppression of these short selling practices over all Spanish stocks, technical analysts in Madrid expressed their suspicions that the move will not alter structural declining trends.
In Italy, the regulator Consob also applied a similar ban but protecting only stocks of financial entities and insurance companies until next Friday. In Spain, the ban is general and set to last during three months until October 23. According to Tuesday’s investor reports from Madrid, in previous occasions equity and derivatives trading has suffered drops of up to 15 percent. The CNMV ruling spells bad news for Bolsas y Mercados Españoles BME, the group that manages Spain’s financial markets.
Last time this measure was introduced, in August 2011, the Ibex 35’s price range went down. BME said today that this type of ban is
“increasingly questioned by market participants because it provokes unintended frictions and consequences on different sectors, products and finance instruments than those that were the object of the ban in the first place.”
Critics of short sales say they have a crowding impact when uncertainty surrounds the markets and just add to investors’ panic. The result is further losses and value destruction, while a few agents make small fortunes. Analysts showed their disbelief, though. Bankia Bolsa noted that, because the ban will be active in summer, trade will be moderately slowed and price distortion not significant.
Why did the regulator bring again such diktat, then? Bankinter Broker and Afi experts gave a hint away: as soon as the ban was decided, the Spanish index Ibex 35 stopped its 5 percent downturn and recovered four percentage points, even if it didn’t leave negative territory.
The Italian index recouped half its losses. Yet, that isn’t an efficient system to resolve investors’ perception of Italian and Spanish stocks. Approving the cancellation of short selling reduces volatility and asymmetry while it is in force, but real weaknesses remain to surface later on.
In usual circumstances, short sellers can make expensive mistakes or listed firms can defend themselves if the threat rests on false assumptions. In all circumstances, short sellers can be proved to have spotted the gap between a solid appearance and the hidden financial holes in balance sheets.