Hedge funds have failed in their bid to convince the US Securities and Exchange Commission (SEC) to overturn temporary restrictions on short selling, as the world's financial regulators continue in their attempts to restore some semblance of order to the roller-coaster US and global markets.
On Wednesday, the SEC announced that it has decided to extend the restrictions on short selling, which have banned the use by traders of 'naked' or uncovered short positions in certain companies' stocks, until midnight on October 17, while the US Congress works on legislation intended to stabilise the financial markets by sucking up about USD700bn in institutional 'toxic' debt. The restrictions imposed on September 18 currently apply to just under 800 company stocks, mainly in the financial and banking sectors, and many national regulators have seen fit to impose similar restrictions in their own jurisdictions, such the UK Financial Services Authority, which has banned naked short sales until January 2009. Australia and Canada have imposed similar restrictions.
In a statement announcing its decision to extend the emergency measures, the SEC said on Wednesday that it: "has taken steps during recent weeks to address concerns regarding short sales in light of the ongoing credit crisis. These efforts relating to short sales have focused particularly on the securities of financial institutions whose health may have an impact on financial stability."
It added that: "The steps the Commission has taken are designed to ensure the continued smooth operation of orderly markets. Our actions have been taken in consultation with regulators of the major developed securities markets around the world, with whom we have coordinated in monitoring market reactions."
However, according to the hedge fund industry, which makes extensive use of shorting strategies in stocks and other instruments to hedge other positions in the market, the regulators' tactics have failed in their objectives to bring calm to the markets, and some argue that, if anything, the short selling restrictions have had the reverse effect and have actually made the markets a more dangerous place.
Prior to the extension of the short-selling ban by the SEC, the Managed Futures Association, the trade group which counts some of the world's largest hedge fund managers among its members, wrote to the Commission urging it to lift some of the restrictions it has placed on traders.
“MFA and its members share the Commission’s deep concerns about the current financial crisis, but we are troubled about the adverse consequences that are likely to result from the implementation of the disclosure order and the prohibition order," said Richard H. Baker, MFA president and CEO.
“While we recognize the Commission’s objective of restoring 'equilibrium' to the markets, we believe the prohibition order instead will lead to increased volatility and a reduction in liquidity to our capital markets as investors who are unable to adequately manage the risks associated with long positions will be unlikely to invest in those positions,” he added.
Baker believes that the upshot of this will be that companies, particularly distressed companies, will lose an important potential source of capital.
The MFA’s letter requested that changes be made to the rule to provide for an exception to the prohibition order for "bona fide hedging strategies," which it argues are a critical risk management tool of investors, enabling them also to provide liquidity.
The MFA has also taken issue with the SEC's requirement that institutional money managers report their new short sales of certain other publicly traded securities.
“We believe that the detailed disclosure required, if made public at any point in time, would still engender adverse market consequences and fully permit other market participants to reverse engineer the proprietary trading strategies of a money manager," Baker said.
"We urge the Commission to indefinitely keep such information strictly confidential," he added.
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