Should we have short sale bans?

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Some countries are banning or limiting short selling but ASIC has told Josh Frydenberg this isn’t necessary. Wayne Swan banned short selling during the GFC. Was this right then and should we be considering it now?

Although it is understandable that some governments are looking to calm financial markets, banning short selling is NOT the right strategy.

Banning short selling did not work during the GFC, and it will not work today. Many academic studies have rigorously shown that short-selling bans do not lead to share price support. Short-selling bans have only led to greater illiquidity, increases in volatility, and higher probabilities of default (Beber and Pagano, (2013); Boehmer, Jones, and Zhang (2009); Marsh and Payne (2012)).

Short selling exists because it allows investors to take positions against companies that have bad managers. Short selling does not destroy companies, bad managers do. If you believe a business has strong growth opportunities, you buy it. If you think the business is overvalued and has a poor outlook due to poor management or suboptimal political or economic conditions, you short-sell. That is how capital markets work. Financial managers of listed companies who do not like this should not even list their companies if they are unable to accept the volatile nature of financial markets. Investors who do not like the volatile nature of equity markets can invest in cash or fixed income.

At present, with the COVID-19 crisis the revenues and profits of many companies will be negatively impacted by the crisis and investors are incorporating their views by short-selling. This is a rational response for fund managers who need to ensure their fund performs as they need to protect the interests of their investors too.