George Kerevan: Why banning short-selling won't stop the market rot

Published on Thursday 11 August 2011 22:08

WILL the UK - not to mention Germany - follow France, Italy, Spain and Belgium in banning the short-selling of European bank shares? Greece already banned short-selling on Monday.

At first sight, the ban seems to have worked, with the Stoxx Europe index of bank shares moving upward yesterday. But Friday's rally has not compensated for a dreadful week. Meanwhile, bank equities can still be shorted on exchanges in London, New York and Frankfurt, so this partial ban is a good way of increasing price volatility in the jurisdictions where it does not apply.

President Nicolas Sarkozy probably initiated this move as a piece of one-upmanship ahead of his summit meeting with Angela Merkel on Tuesday. It could easily backfire. What smells of a panic move will only draw attention to the inherent threat to Europe's banks from their exposure to eurozone sovereign debt.

Take Socit Gnrale, the eurozone's third biggest bank, which lost nearly a quarter of its market value on Wednesday. While those shares bounced back, they are still worth only half what they were at the start of the year. Last week the bank revealed second quarter profits down 31 per cent, hurt by Greek write-offs. It still owns €2.65bn worth of Greek bonds and says its 2012 profit target will be "difficult to achieve".

Even if the UK joins in the ban - unlikely but Chancellor Geroge Osborne might want to collect political IOUs from Sarkozy - it is doubtful the market price of big continental banks can be protected by government fiat. Short-selling is not the underlying cause of the share slide. That has more to do with the obvious uncertainties in eurozone policy. Witness the fact that spreads of French ten-year bonds over German bunds reached a 16-year high in recent days.

There are also clear signs that European banks are having genuine solvency problems. They have been parking less overnight money with the European Central Bank (ECB), suggesting a shortage of liquidity. This is confirmed by a sudden jump in ECB overnight lending to banks. This could signal a major bank in difficulties.

There is abundant evidence - not least from EDHEC, the French grande cole - that shorting is a necessary market mechanism that provides much-needed liquidity and acts as a deterrent to complacent management. Besides, experience in banning short-selling hardly gives cause to think it works. In 2008, the UK regulators banned short-selling of financial shares, yet only days later Bradford & Bingley collapsed. Lesson: by the time a ban is introduced, the rot has already set in. Think horses and barn doors.

Foreign investment robust, but tourism another issue

THE boss of Jaguar Land Rover, Ralf Speth, is worried that this week's riots - or at least the graphic pictures on global television - could damage the confidence of foreign investors. Note: Jaguar Land Rover is owned by Tata, India's largest business conglomerate. In the 2002 Gujarat riots 1,044 people were killed and 35,000 arrested. Yet Indian GDP will grow about 8 per cent this year.

Of course, the UK riots could impact on inward investment, particularly in property. Cash-rich private and sovereign wealth funds have been keen on English regional shopping centres, which have attractive yields. So it is bad news that The Times of India is giving prominence to a story that one in ten of the businesses looted in London belonged to the Gujarati community, who are blaming police inaction.

However, memories are short and global, long-term investment opportunities limited, so it is unlikely foreign direct investment (FDI) will be severely affected. Proof: the pound sterling exchange rates stood firm this week, and the latest UN World Investment Report shows the UK is still the most favoured destination for FDI in Europe, and the third worldwide. In 2010, the stock of FDI into the UK was a stunning $1.09 trillion.

One industry that could suffer consequences is domestic tourism, especially the Olympic Games. Vardan Kondvikar, editor of India's Lonely Planet Magazine, was quick to warn readers: "Try to avoid travel to the UK this week." That's not an idle threat. By 2020, there will be 50 million outward and affluent Indian tourists looking for somewhere to visit.