Short Selling in France during the Crisis, the Bans and What Has Changed since the Euro Correction

1. Short Selling in France during the Crisis, the Bans and What Has Changed since the Euro Correction Emmanuel Fragnière and Iliya Markov November 2010

2. Reading Questions What is short selling and why is it viewed by market regulators as a dangerous practice? What effects did the short selling bans have on liquidity and price discovery? Is naked short selling more dangerous than conventional short selling? What are the main points of the French restrictions on short selling? How were the French restrictions on short selling coordinated with the rest of Europe?

3. Reading Questions What effects did the restrictions in France and the rest of Europe have on the markets and the euro? How did restricted French stocks perform relative to unrestricted ones? How did restricted French stocks perform relative to similar stocks in countries with lighter on no new restrictions on short selling? What are the latest developments and trends concerning short selling in France and Europe? Overall, were the restrictions on short selling in France efficient or not?

4. Preliminaries • Following the collapse of Lehman Brothers most of the world’s major economies introduced restrictions on short selling • Most of the market regulators intervened in the period September-October 2008 • France introduced a ban on naked short selling and a disclosure regime for net short positions on 22 September 2008 • In the view of the French authorities short selling depresses stock values below the market equilibrium

5. What is Short Selling? • A trading strategy where the trader profits from a loss in the value of a security • There are four main steps in short selling • Borrow a security from a lender • Sell at current market price • Buy an identical security after a period of time • Return the security to the lender • If the security has depreciated in the meantime, the trader earns the difference between the selling and buying price

6. Previous Studies of the Bans on Short Selling • Clifton and Snape (2008) The short selling ban in the UK had a negative effect on bid-ask spreads, trading volume, depth and turnover of affected stocks. • Boehmer, Jones and Zhang (2009) Short selling bans had a negative effect on bid-ask spreads, price impacts and intraday volatility. • Beber and Pagano (2010) Bid-ask spreads of affected stocks in the US increased 4.5 times more than bid-ask spreads of unaffected stocks.

7. Previous Studies of the Bans on Short Selling • Gruenewald, Wagner and Weber (2010) • Short selling can be replicated by futures and options. Therefore bans are inefficient unless imposed on futures and options as well. • In naked short selling clearing agencies can ultimately source the stocks and deliver them to the buyer. Therefore bans exclusive to naked selling are economically unjustified. • Copeland (2010) Short selling bans exclude negative information from the process of price formation and can support stock values above the market optimum. Therefore the bans hinder the optimal allocation of resources in the economy.

8. Regulatory Developments in France • 22 September 2008 – Temporary ban on naked short selling and disclosure regime for net short positions for 15 banks and financial institutions. Extended several times. Still open • 19 May 2010 – German ban on naked short selling for 10 banks and insurers and Eurozone government bonds – conflict with France, which did not support the measure • 9 June 2010 – Germany and France reconcile positions and ask the EU to accelerate financial reform, especially settlement and delivery of securities in the EU • 11 October 2010 – France adopts a law for banking and financial regulation, which gives the AMF (French market regulator) the power to impose permanent restrictions on short selling

9. Comparison of Restricted and Unrestricted French Stocks • Study period: 1 August 2008 – 31 October 2010 • A portfolio of unrestricted stocks outperforms a portfolio of restricted stocks 81% of the time after the introduction of the ban • At the lowest point the portfolio of unrestricted stocks falls to €596, while the portfolio of restricted stocks falls to €464 • The portfolio of unrestricted stocks is less volatile than the portfolio of restricted stocks • The correlation coefficient is 0.94

10. Comparison of Restricted and Unrestricted French Stocks

11. Comparison of French and Swiss Portfolio of Financial Stocks • Study period: 1 August 2008 – 31 October 2010 • Short selling ban in Switzerland: 19 September 2008 – 19 December 2008: only 3 months • The lift of short selling ban in Switzerland is followed by a strong short-term appreciation of the Swiss portfolio relative to the French one • The French and Swiss portfolios have a correlation coefficient of 0.97 • The Swiss portfolio is on top of the French portfolio 83% of the time after the introduction of the ban in France

12. Comparison of French and Swiss Portfolio of Financial Stocks

13. Study period: 1 August 2008 – 31 October 2010 Sweden did not impose any new restrictions on short selling In terms of euro, the Swedish portfolio performs worse than the French one. This is attributable to a significant depreciation of the Swedish krona relative to the euro In terms of kronor, however, the Swedish portfolio performs similar to the French one The two portfolios have a correlation coefficient of 0.94 Comparison of French and Swedish Portfolio of Financial Stocks

14. Conclusions • Short selling bans are detrimental to market liquidity and price discovery • The singling out of naked short selling is economically unjustified • A portfolio of restricted French stocks does not perform better in terms of stock price and volatility than a portfolio of unrestricted French stocks • A portfolio of restricted French stocks performs similar to a portfolio of Swiss or Swedish stocks of the same type • Overall, the restrictions on short selling in France were inefficient • Despite the strong evidence against the bans, the AMF has recently been given more power to restrict short selling