Thursday, September 18, 2008

SS stop loss

Short-selling (naked SS) is now being banned on both sides of the pond. This is a disorderly market and dysfunctional equity trading matter.
When traders aggressively short sell to bring down major bank stocks in the present climate they threaten whole indices. This begs the question of what are their paltry trading gains worth compared to the losses across the rest of equity investors and traders’ portfolios? Short sellers argue they are part of the stock market's efficiency. But, market efficiency is a long term concept. They can be grossly inefficient short term and right now it seems that the short term is as long as it gets.
The dysfunctionality exposed within banks and in trading markets, and most of all in credit derivatives, may be described as one hand not caring about what’s the other hand is holding. Hedge funds oppose the SS ban on the grounds that this is an individual stock issue e.g. HBoS or Lehman. But, major banks are at this time more than just individual stocks especially when markets are jittery and easily spooked. One can also blame institutional investors for continuing to lend stock.
The lending of bank shares without which short selling by day traders would be much harder should therefore be temporarily banned also. Options trading seems a far more orderly way of short selling than stock lending and CFDs.
What we have here are market participants not realising or not caring that risks are not just external but also contributed to by internal silo thinking and silo responsibility.
In banning the SS it is unclear how well this can be policed, whether spread-betting will be stopped, and most of all whether Contracts for Difference (CFDs) are effectively stopped.
These are routinely used in stockmarkets. CFD firms advertise the advantages of CFDs as tools for trading shares (long or short) using borrowed money (called margin). Traders can buy stock for a 10% to 20% margin so that profits and losses are multiplied 5-10 times. CFDs are for the stockmarket trader rather than for investors, for Day-traders, short term traders, for share volatility between 1-20 days and why CFDs are the preferred vehicle for shorting stocks, making money during falling prices. CFDs have been available in the institutional market for many years and were introduced to retail clients ten years ago.
They are said to account for about 25% of daily turnover on the LSE and for up to 50% of volume on certain days. CFDs are available on stocks in most Western markets including USA until recently banned. CFD traders such as Worldco were run out of town by market insiders because they were making too much money off the floor specialists. One alternative is to focus on options instead.
Banning short selling may be an empty gesture to please the voters. It makes for a good headline. All traders have to do is shift attention to the options or futures market to achieve the same goal. Some commentators say short selling regulations are raised during election campaigns.
Short-selling of financial stocks is now banned in the United Kingdom under rules to be drawn up in detal over the coming months by the FSA. The ban is announced after a week in which the shares of leading financial institutions have come under intense pressure of turmoil in financial markets of shares falls, risk downgrades and spikes in overnight deposit rates.
The change in the rules is the FSA’s second attempt to curb short-selling. It had already banned short-selling of companies raising cash through a rights issue. There is too a political backlash against short-selling, which is blamed for contributing to the crisis of confidence in some of the largest banks.
In the US, SEC chairman Christopher Cox proposed that big investors, including hedge funds, begin publicly reporting their short positions daily. Cox also announced that the SEC would be subpoenaing hedge funds and other traders as part of "enforcement measures against market manipulation" and examine "past trading positions in specific securities" -- which means financial-company stocks. The rule "will be designed to ensure transparency in short selling," Cox said. "Managers with more than $100m invested in securities would be required to promptly begin public reporting their daily short positions. Managers currently report their long positions to the SEC at the end of each quarter. It is unclear if they must report long positions daily now too. Liberal Democrat shadow chancellor Vince Cable called on the FSA to stop hedge funds short-selling HBOS shares following its stock market plunge. The FSA have now done so, from midnight tonight. But, the sharp falls in the HBOS share price may not be short selling according to Short selling in HBOS increased slightly on Friday, but less on Monday when the stock fell heavily. data shows 2.2m HBOS shares loaned by institutional investors and pension funds on Monday, but the level of short selling was low compared to other stocks and previous shorting in HBOS shares.
Hector Sants, chief executive of the FSA, said: "While we still regard short-selling as a legitimate investment technique in normal market conditions, the current extreme circumstances have given rise to disorderly markets. As a result, we have taken this decisive action, after careful consideration, to protect the fundamental integrity and quality of markets and to guard against further instability in the financial sector."
Yesterday Hector Sants was addressing asset managers telling them: I ought to, perhaps, begin by saying that I subscribe to the view that economic and market cycles are inevitable. Indeed, a downturn of some magnitude was largely expected by commentators and regulators. This is true, but the warnings to this effect were barely noticeable, and the idea of the inevitability of cycles was more implicit than stated loud and clear. Several banks resisted this aspect of Basel II regulations. Sants continued,
A correction of risk pricing was, thus, foreseeable. But what was not anticipated was the collapse of investor confidence and subsequent liquidity squeeze. As I have said before, the FSA sees this as a three stage cycle, beginning with market confidence and liquidity issues, then moving to a recapitalisation of banks and finally where we are now - working through the implications of the impact of those first two stages on the real economy. This third stage has potentially severe implications for consumers and presents a credit management challenge for financial firms. But is relatively well trodden territory for regulators and, I would hope, for firms’ management. I now believe that market confidence can only return when investors know where the bottom is. We are not there yet, as the events of this weekend have shown, but we are getting closer.
He ends on a theme that "there are also lessons to be learned from recent events beyond the supervisory regime. They also raise questions about how regulators address the issue of ensuring the quality of markets." and mentions SS when also referring to Hedge Funds saying it "...can be used for abusive and manipulative purposes... the risks of this type of abusive behaviour occurring.." etc. but nothing about stopping it as per the announcement today nothing about CFDs or the role of stock lending? So, we may suppose that the regulatory action today is politically triggered more than a sole initiative of the regulatory authorities.

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