Memo ASIC: The ban on short-selling must stayArticle from: Font size: Decrease Increase Email article: Email Print article: Print Submit comment: Submit comment By Terry McCrann
November 21, 2008 12:00am
ASIC partly lifted the ban on short selling on Wednesday and the market dropped 5 per cent in the next two days to - yet another - four-year low.
So, it's all the fault of short selling and the practice should be banned? No and "yes", in order.
No, "it's not all the fault" of short selling. The proximate cause of the drop, mostly yesterday, was the overnight dive preceding it on Wall St.
That and of course the toxic climate of fear, which means we are now "all sellers" at the slightest provocation.
Blaming any given drop, whether of the market overall or of an individual stock, entirely on short selling, is as silly as the two main arguments of proponents of short selling.
That after short selling was banned on September 21, the market kept falling anyway. So, see, don't blame short selling.
While the second one is that all those high profile stocks that were shredded by short selling, like Allco, ABC and Babcock & Brown, had been way over-priced, to put it at its mildest.
So the shorters performed a service, acting as "price-discoverers". Or even a much more noble public service - unmasking main-chancing fabulists.
All of these for and against arguments are straw men. And so, no, I would not argue that these week's fall "proved" short selling was evil.
But yes it should be "banned". For the very simple reason - and I'll spell it out for ASIC boss Tony D'Aloisio and all the others that have difficulty understanding - it is W-R-O-N-G.
Now why have I put those words in quotation marks? Because I don't believe it is necessary to actually ban short selling. That is real short selling.
Simply, to first require on huge penalty that brokers fulfil the exact letter of their settlement obligations. And second, to revoke the change in the Tax Act which makes so-called covered short selling possible.
To explain. Real short selling, where you sell a share you do not own - so-called naked short selling - is fundamentally incompatible with the obligation of a seller to deliver the shares for settlement in three days.
You can only do it if you buy back on the same trading day; and then only at some settlement risk. Because the seller to you mightn't meet its delivery obligation.
Having to buy back on the same day also carries basic market risk. You couldn't be certain of the sure thing of forcing the price sustainably lower.
The simple way of dealing with this would be to impose a penalty equal to say the value of the trade on any broker/trader that could not deliver scrip because they had short-sold.
Do that and you don't have to ban naked sales. They'd ban themselves.
That leaves the so-called covered short selling. Which isn't actually short selling. An institution purports to lend shares to a seller - who has to return them at some future time.
It does no such thing. Shorter Joe Smith can't deliver BHP shares owned by say, the AMP, for settlement. So the "lending" institution passes full legal title to the seller.
The seller is selling shares he/she/it owns. Yes, he/she/it has a contractual obligation to "return them". But they will be different BHP shares.
So in legal reality, the "lender" has disposed of the shares, and would trigger realisation issues under Tax Act. Except the Tax Act was changed in 1989 to deem this not a realisation.
Change the Tax Act back and covered short selling stops instantly.
This should be telling people like D'Aloisio something which they seem incapable of understanding. That short selling of the physical securities is not the mere opposite of long-buying. It is fundamentally incompatible with the market process.
Now the "arguments" for shorting from those like the hedge funds is entirely self-serving. That's fine; they have profits to chase. And their self-serving arguments are easy to rebut.
The "explanations" from ASIC to allow short selling are embarrassing.
In announcing last week the ban would be lifted, ASIC noted how it had been previously extended as "market conditions remained difficult".
If it's such an entirely valid and appropriate practice, why would that matter? So is ASIC going to place a ban on long-buying on the occasion of similarly difficult market conditions?
Further, if covered short selling is so entirely valid, why is the ban continuing on financial securities?
Indeed, why is covered short selling acceptable but not naked?
Talk about missing the wood among all those trees. ASIC thinks it has to deal with the problems of short selling, but is utterly incapable of seeing the problem is short selling.
RBA Governor Glenn Stevens said on Wednesday night confidence was a crucial ingredient in coming through this turmoil. I for one have no confidence in ASIC.
