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On Monday, the Australian securities exchange announced that naked and covered short selling is banned. A re-assessment will take place in one month, at which point they will decide whether to permit covered short sales for non-financial stocks.
While this might provoke sighs of relief at Macquarie Bank and Babcock & Brown, the credit default swap market remains open and provides an ability to short credit. However, what is best, an orderly exchange-traded shorting system, or the unregulated CDS casino? Expect to see credit default swap premia react sharply.
Australia follows Taiwan, which at the weekend banned short sales in the component stocks of the Taiwan 50, the Taiwan Mid Cap 100 and the Taiwan Technology Index, if they are trading below the previous session's closing price. Both follow in the footsteps of the UK and US. While only a handful of Asia's markets allow shorting, it looks a safe bet that all of the others who were contemplating allowing it have now closed those files for the foreseeable future.
"These bans on short selling make no sense," says Peter Douglas of GFIA in Singapore. "Restricting market liquidity, impairing market functionality, and limiting risk management options û in these market conditions! YouÆd have thought that regulators would want to normalise the financial system."
If a short position is on a hedge fund's books, then it can remain there. The restriction is on executing new short positions.
Florence Lombard, chief executive of AIMA voices an opinion, that is shared by virtually everyone in the alternatives industry, (including those in the trade media, although the non-financial press is depicting hedge funds as irresponsible scapegoats), that short selling is not to blame for the declines in share values that led to the UK being first to cease shorting.
"The true cause appears to be a widespread lack of confidence by all investors, related to much deeper market issues," she says.
What affect will it have on hedge fund performance? If the markets go straight back up to new dizzying heights, and the hedge fund industry has been shoe-horned into being long-only, then they should perform well in the short term, especially as Asian hedge fund strategies are skewed towards long/short equity with a bias toward the long side.
"As hedge funds tend to have a long bias, this actually should be beneficial on the whole for hedge fund performance," says Guy Medcraft, head of business development in the alternative strategies unit of Commerzbank in Hong Kong. "However the wider concern is whether by banning (certain types of) short selling it creates an artificial equity market."
If shorting attains pariah status, then hedge funds risk mutating into a pointless and expensive replications of a long-only funds. Hong Kong and Tokyo may not be far behind in announcing similar shorting restrictions.
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