Friday, August 19, 2011

US Hedge Fund Industry Urges EU to Reconsider Short Selling Restrictions

In letters to EU policymakers and market authorities on their decision to restrict short selling, the Managed Funds Association urged them to consider the past experience when market authorities have implemented short sale restrictions and to refrain from or reconsider their decision to implement a short selling restriction, as evidence shows that such bans have proven to be more harmful than beneficial to markets. Specifically, said the Managed Funds Association, past experience with short selling restrictions show that restrictions are counterproductive, further deteriorate investor confidence and increase volatility. The letter was sent to, among others, the European Securities and Markets Authority, BaFIN, the European Central Bank, and EU Commissioner for the Internal Market Michel Barnier.

In addition, the MFA noted that restrictions impair the ability of investors to manage risk, leading many to sell additional securities to balance their portfolios. Restrictions freeze the ability of financial institutions to raise capital through convertible bond and convertible preferred security issuances by preventing investors to purchase the convertible products and hedge the risk with offsetting short sales. In addition, the absence of a consultation period undermines investor confidence and creates market uncertainty with respect to interpretive guidance and compliance efforts.

The MFA also said that the use of a short selling restriction as a policy tool will likely undermine the confidence of investors who may view it as a sign of desperation or interpret it as an indication of the severity of a financial institution’s circumstances. A ban on short sales, even when temporary, harms liquidity and efficiency and disrupts markets. Short sale bans undermine the bona fide hedging strategies that are a critical risk management tool of investors and enable them to make investments on the long side of the market.

The current short sale orders by competent authorities have created a great deal of market uncertainty and disruption with respect to the trading of broad-based indices, emphasized the MFA, including futures, which consist of one or more restricted securities. Investors commonly short broad-based indices as a risk management tool. Many are finding that under the short sale restrictions, this is no longer available as a way for investors to manage portfolio risk. Especially in a time of extreme market volatility, said the MFA, the loss of the ability to hedge market risk is causing great harm to investors and forcing investors to make additional sales of securities in order to rebalance their investment portfolios and limit market risk.