Are Newly Extended Short-Selling Bans Hurting European Financial Markets?

While recent bans on short-selling in France (NYSE:EWQ), Spain (NYSE:EWP), Italy (NYSE:EWI), and Belgium are meant to protect financial stocks, they may instead concentrate bets against banks elsewhere in Europe, but that hasn’t stopped them from renewing the bans. European financial stocks have declined 8% since August 12, when he bans were first put in place. Now Spain and Italy have extended their bans through the end of September, while France says its ban may last until November 11, though all three said they would lift the bans sooner if markets were to stabilize.

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Short-sellers sell borrowed shares they plan to buy back later at a lower price, a common practice among many investors but highly controversial for its tendency to roil markets. Alessandro Beber, a professor at Cass Business School in London who has studied short-selling bans in 30 countries, says, “In contrast to the regulators’ hopes, the overall evidence indicates that short-selling bans at best left stock prices unaffected and at worst may have contributed to their decline.”

After regulators imposed a short-selling ban in 2008, British (NYSE:EWU) financial stocks fell 41% over the next four months, while the benchmark FTSE 100 index fell a more modest 15%. When the Securities and Exchange Commission issued a 3-week ban on short selling in the U.S. that same year, the 880 stocks affected fell 26% while the S&P 500 Index (NYSE:SPY) declined 22%.

Bob Penn, a financial regulation partner at law firm Allen & Overy LLP in London, says “The problem with a partial ban — which is what we have now — is that it moves the problem to other parts of the system.” Penn says short sellers are likely to turn their attention away from financial stocks in countries with bans, and instead focus their short selling on other markets. In the case of the European Union, where the economic fates of all countries are somewhat dependent upon each other, the short-selling bans of any one country could hurt its neighbors, and in turn hurt itself, a fact evidenced by the overall decline in European bank stocks over the past two weeks.

Shares of French bank Societe Generale SA have declined 10% to their lowest levels since 2008. Italy’s Unicredit SpA has declined 14% since August 12. And yet Richard Portes, professor of economics at London Business School, says “Short selling equities is not a significant danger to financial stability, so these bans are irrelevant.” According to Portes, “The serious problem is speculation against financial institutions and sovereigns using naked credit default swaps. They should be banned.”

Still, just the fact of the bans signals “officials’ nervousness”, according to Richard Reid, director of research at the International Centre for Financial Regulations. Simple speculation that Germany (NYSE:EWG) might impose its own restriction on the equity market were enough to hurt stocks Thursday, as it signaled to investors that the nation’s finances may be deteriorating. The German DAX Index declined 1.7% today by close, but fell as much as 4% intraday, despite the fact that German financial markets regulator BaFin said it wouldn’t expand existing curbs on short sales, which the Finance Ministry confirmed.