67 Pages Posted: 29 May 2009 Last revised: 20 Apr 2010
Date Written: May 29, 2009
Short selling has long been regarded as aggressive speculation that destabilizes financial markets, raising concerns about their moral foundations. This view gathered unstoppable force in September 2008 when short sales were seen as the principal cause of precipitous falls in the market price of financial sector stocks. As a result, most developed market regulators declared a ban on short sales in financial sector stocks. However, many empirical studies indicate that short sales are, in fact, a beneficial source of market efficiency. This view is confirmed by studies on the September 2008 ban in the US and the UK, which show that the prohibition did not yield any concrete welfare benefits, especially in terms of reduction of price volatility. On the contrary, it had an adverse impact on liquidity. The market abuse rationale, offered as the main justification for the September 2008 ban, is also unconvincing. Furthermore, US and European regulatory order banning short-sales revealed how disparate are the regimes governing cross-border securities trading. This article argues that the best way to regulate short sales is through a dual strategy of disclosure and short trading halts, rather than a prohibition or an uptick rule. The short trading halts should be based on a sophisticated circuit breaker system that is focused on market conditions and preserves the proper function of the price formation mechanism. Disclosure and short trading halts should be complemented by a strict settlement regime, as recommended by IOSCO. The FSA’s and the SEC’s proposals are incomplete. Also IOSCO’s principles are so high level that they cannot close the gaps. Therefore, the endorsement of the suggested combination of disclosure and sophisticated circuit breaker system can serve three important objectives. First, it would preserve liquidity enhancing short sales and the valuable information that these trades carry. Second, it would check downward price pressures due to herding and market irrationality. Third, it would lead to rather compatible national regulatory regimes laying down the foundations of a new global framework for the regulation of short sales.
Keywords: short selling, 'naked' short sales, regulation of short sales, circuit breaker, uptick rule, SEC, FSA, CESR, IOSCO, Ban of short Sales, Market Abuse, herding, EMH, arbitrage, adaptive markets
JEL Classification: G20, G28, G38, K22
Suggested Citation: Suggested Citation
Avgouleas, Emilios, A New Framework for the Global Regulation of Short Sales: Why Prohibition is Inefficient and Disclosure Insufficient (May 29, 2009). Stanford Journal of Law, Business, and Finance, Vol. 16, No. 2, 2010. Available at SSRN: https://ssrn.com/abstract=1411615