Following the decision to end the short-selling bans across Europe, the World Federation of Exchanges commends authorities’ efforts to return to normal operations of fair and orderly markets in the region.
Academic evidence almost unanimously points towards short-selling bans being disruptive for the orderly functioning of markets, as they are found to reduce liquidity, increase price inefficiency, and hamper price discovery, according to a WFE’s paper. Instead, evidence suggests that short-selling bans during uncertain times seem to exacerbate, rather than contain, market volatility.
Nandini Sukumar, Chief Executive Officer at the WFE, commented: “It is industry experience that short-selling bans do not have a positive effect on market activity or price levels. Banning short-selling interferes with price formation, thereby increasing uncertainty. That can only artificially amplify volatility and probability of default, the opposite effect to that claimed, and hampers the ability of markets to serve the real economy. We welcome the decision to allow regulated markets, that have demonstrated they are resilient and capable of operating as they should in a crisis, to now resume normal operation. We look forward to supporting Europe’s measures to rebuild the economy.”
Bans on short-selling were implemented in March and at that time, the WFE criticized the measure by explaining that short-selling bans inhibit orderly markets rather than promote them, unlike circuit breakers put in place by exchanges to slow markets down in times of stress.
While circuit breakers allow participants time to assimilate information, with the effect of making trade-execution decisions more informed, short-selling bans prevent market participants trading as effectively as possible, thereby making price information less accurate. This undermines the crucial role that exchanges play in establishing the definitive, authoritative price for financial instruments at any given time.
In March, WFE also called market participants to reassess investment valuations and reminded them of a variety of crisis measures to address the pressures on the financial system, including circuit breakers and pricing bands. The federation also stated that it is important that markets remain open and that the hours of trading remain as normal, to preserve the benefits of price formation and access to liquidity for society. This will help central banks to transmit their monetary policy and promote financial stability.
The WFE is based in London and represents over 250 market infrastructure providers, with 35% members in Asia-Pacific, 45% in EMEA, and 20% in the Americas. WFE’s 57 member CCPs collectively ensure that risk-takers post some $800bn (equivalent) of resources to back their positions, in the form of initial margin and default fund requirements. WFE exchanges are home to nearly 53,000 listed companies, and the market capitalization of these entities is over $93 trillion; around $88 trillion (EOB) in trading annually passes through WFE members (at end 2019).