Alan Kohler
Known unknowns in today's trade
Exactly how the sharemarket operates today with a total ban on all short selling is anybody’s guess.
In theory it should return to the 'good old days' of 20 years ago, before long-short hedge funds and securities lending came to dominate affairs. Those days, you may recall, included a certain October 20, 1987, when the all ordinaries index fell 25 per cent because of real, as opposed to short, selling.
But that was from an extreme bull market peak, not well into a bear market. At the intra-day low point last Thursday, the all ordinaries had fallen 25 per cent from the peak on May 19, and 33 per cent from the peak of November 1 last year.
So in theory our market is more likely to rise today than fall – and possibly a lot – as a major source of selling is removed and trading is rendered 'clean', with nothing but real owners of company securities doing business. But events have suddenly become even less predictable than they were already.
If the market does spike because of short covering by hedge funds and the disappearance of their strategic selling pressure, then such a rise could not be described as soundly based on fundamentals and therefore may be short-lived.
Then again, the likely ruin of the hedge fund industry could actually produce a wave of selling, not buying, since these funds are long as well as short.
Hedge funds will now be hit by redemptions because their raison d’etre has been removed. They will be forced to sell assets to meet the redemptions and repay debts.
If they can’t do that quickly enough, some bankers may hit the red button marked 'Receivers', to take the selling into their own hands. In that case the selling might be done at lower prices.
Last night ASIC said the measure was for just 30 days, at the end of which it would reassess the situation.
But a month is an eternity for hedge funds. Like fruit flies, they go through entire life cycles in that time. A month is not temporary, it’s effectively permanent.
Also, heavy-handed regulatory intervention of this sort could panic everybody else, on the grounds that if the regulators are panicking and not sleeping at night then perhaps investors should join in.
As my colleague Robert Gottliebsen writes this morning, hedge funds have to some extent brought this on themselves by going too far, but without wishing to suggest this is an exact analogy, it’s a bit like the Afghanistan Government banning opium farming.
Yes it has gone too far, but can you really just ban it now? What would happen to the Afghan economy?
Along those lines, one stock that is likely to fall today is that of the ASX itself; the difference between last week’s trading volumes and this week’s will give us an idea of the extent of activity based on short selling. It won’t be insignificant.
This is one regulatory action about which there is unlikely to be consensus between ASIC and the ASX; the response of the ASX’s supposedly independent supervisory division today will be very interesting.
And what about the contracts for difference (CFD) market? This is where retail investors do their short selling.
Some CFDs, but not all, are market-backed, which means the over-the-counter providers actually buy or sell (short) on the ASX whatever their clients trade on their CFD platforms. The other type of CFD and equity swap (the wholesale variety of CFDs) is simply a bet between two parties about whether a stock or an index will rise or fall.
The size of each portion of the CFD market is unknown, as is the size of the CFD market overall.
And then there are the ASX exchange-traded CFDs, launched just after the market peaked in November 2007. Is short selling of these banned as well? Will hedge funds simply move across to CFDs and equity swaps to do their shorting?
In other words, can ASIC really ban short selling at all?
It can issue a solemn proclamation as it did last night, but is ASIC chairman Tony d’Aloisio like Canute the Great, who set his throne by the seaside and commanded the water not to wet his robes – to demonstrate the limits of the power of kings (it worked – he got wet).
Will the actions of regulators around the world to curb short selling demonstrate something similar? Or should they be careful of what they wish for?
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