The London Stock Exchange welcomes the Financial Services Authority’s (FSA) proposed changes to the short selling regime, which create a clear framework for disclosure while removing the ban on short selling of certain financial securities.
In particular, research commissioned by the London Stock Exchange supports the Financial Services Authority’s decision yesterday to lift the temporary ban on the short-selling of certain financial securities introduced on 19 September.
Adam Kinsley, Director of Regulation at the London Stock Exchange, said:
"Short selling has become an emotive subject, because its potential misuse is more readily understood than the variety of constructive reasons why a market participant might sell stock it doesn’t own. Our research suggests that the ban on short selling did in fact impair liquidity provision and market quality in affected securities – this increases the cost of investing in equities. The FSA has reviewed the impact of its temporary short selling measures, and should be applauded for its balanced approach and proposals."
The research by the Capital Markets Cooperative Research Centre examined the impact on liquidity of the short-selling ban, comparing liquidity in fifteen FTSE100 financial sector stocks in which short-selling was prohibited with a control group of 78 FTSE 100 [1] securities in which short selling was not prohibited.
Tracking changes in liquidity and market efficiency in the 30 trading days prior to and following the implementation of the short-selling ban, the study found a marked weakening in the liquidity of securities in which short selling was prohibited. Indeed, while there was a market-wide decline in liquidity during the period of the study, its findings suggest that the stocks included in the short-selling ban were more severely impacted, with the fifteen FTSE100 financial sector securities covered by the ban suffering a widening in spreads 150 per cent greater than was observed in a control sample of the remaining, unaffected FTSE100 securities.
The research found that liquidity was significantly weaker in the stocks affected by the ban than in the control sample as reflected in several key measures of liquidity:
- Average spreads: stocks subject to the short-selling ban experienced a subsequent increase in spreads that was 150 per cent greater than the increase in spreads in the control sample. During the 30 trading days prior to the introduction of the ban, the average spread had been steady for both groups, but increased by 140 per cent from 15 basis points (bps) to 36 bps for those stocks which were no longer available for short-selling, compared with a rise of only 56 per cent to 20 bps for the control sample.
- Market depth: as measured by calculating the volume required to move the bid and ask price in each stock by one per cent, market depth declined more markedly for the stocks subject to the ban, decreasing by approximately 59 per cent, compared with only 43 per cent for the control group.
- Trading activity: the number of trades and volume of shares traded fell by roughly ten per cent in the affected stocks after the ban, but actually increased by 50 per cent in the control sample. The divergence in trading volumes was reflected in turnover, which fell by 21 per cent in the affected stocks, but increased by an average of 42 per cent in the control sample.
[1] In total there are 15 stocks in the FTSE 100 that were original subjects of the FSA ban. The control sample comprises the remaining FTSE 100 stocks not included in the ban, net of mid-sample changes that occurred in the index during the period of study
