From the desk of John Arnesen,
Consulting Lead, Pierpoint Financial
Many of you reading this probably groaned when, during the spread of the pandemic last year, several countries implemented a ban on short-selling, claiming it as a responsible move to maintain orderly markets. You know the story. Austria, Belgium, France, Greece and Spain, Italy, South Korea and Malaysia. ESMA stated that the measures were justified by 'current adverse events or developments which constitute a serious threat to market confidence and financial stability and that they are appropriate and proportionate…..'
Naturally, there were detractors. The Managed Fund Association (MFA) CEO, Bryan Corbett, drew attention to bid-ask spreads that had widened more than 15% compared to unrestricted shares. He went on to say that the price spread was effectively a tax on investors trading in the affected securities, and worse diminished liquidity at a time when the markets need it the most.
A similar sentiment was echoed by the CEO of the World Federation of Exchanges, Nandini Sukumar, who couldn't have put it better, so I'll quote him in full, "Banning short-selling interferes with price formation, thereby increasing uncertainty. That can only artificially amplify volatility and probability of default, the opposite effect to that claimed and hampers the ability of markets to serve the real economy. It is not- and never has been- true that bans have any other, positive effect on market activity or price levels."
Sadly, conscience and accurate statements like this seem to fall on deaf ears. The wealth of academic research doesn't convince detractors either; read this paper by Linquan Chen, Alok Kumar and ChendiZhang
So short-selling is bad, and those who contribute to the practice by lending stock must be bad people too. That would imply that heavily shorted companies must have depressed share prices, no? So let's take a look using May's report from the good people at IHS Markit.
Every month, Sam Pierson, Director, Securities Finance at IHS Markit, publishes a round-up of the prior month's activity and provides data, by region, of valuable statistics. For US data, there is a list of 'Top revenue-generating Americas equities' If I work from the widely-held premise that securities lending supports short-selling, then there is some logic in assuming that the highest generating lending revenue stocks will be the most shorted as their fees will be the highest. I will refer to the table below. All of the data I refer to is sourced by Yahoo Finance.
SoFI Technologies Inc
Social Finance Inc is a Californian based fintech that offers a range of online banking services and hopes to challenge traditional banking along with a host of competitors. It joined the Nasdaq on June 1st as a result of a SPAC merger. The free float is 61mm with a total outstanding of $800mm. The share price in May started the month at $17.00 and ended the month at $22.65. The short interest is low compared to total outstanding shares at 3.54%, but against the free float, it's 47%. There appears to be no relationship between the share price and short interest, or it could suggest that the lending of SoFI stock is not driven by short positions alone.
Blink Charging Company
As you might guess, Blink provides charging services and equipment for electric vehicles and network services based in Florida. It's a tiny company with a market cap of $1.63bn, but it will join the Russel 2000 in late June. The free float of $35.98mm shares has 34.42% of them shorted. That represents a relatively high figure, and yet the share price in May opened at $35.48, dropped to a low of $26.22 on 13/5/21, but then rallied for the rest of the month, closing at $34.00. It went on to peak at $40.00 on June 8th. So those that lent the stock and collectively earned $15.6mm in revenue did so while the stock price ostensibly rallied for half the month. Does this point to short-selling destroying the share price?
Churchill Capital IV Corp
Churchill is a SPAC that announced a merger with Lucid motors in February 2021, an electric vehicle company. In reading analysts recommendations, they generally think it a value buy, but all the price increase happened around the announcement of the merger when it shot from $17.85 to $ 59.00. Since then, it has done very little. In May, and since, it's ranging in a two-dollar band around $20.00. Its short interest as a percentage of free float is around 26%. Yet again, I see no discernable effect on its price, given that a quarter of the available shares are shorted.
They all have relatively high short interest, but that factor has failed to lead to a marked decline in share price. So I wondered if a declining share price was accompanied by high short interest. I won't go through the rest as it's not particularly interesting for the reader, and I expect a similar pattern to emerge.
Tesla is always in the news for one reason or another, so let's look at how they fared in May. Not so well as it turned out. It started the month at $709.00, and then it was in a steep decline to $563.46 by 19/5/21 to recover by month end to $625.22. See chart below. Those damned short-sellers must have been hard at work all month, right? No, actually, of the $775.06mm of free float, only 4.16% are shorted. The decline in share price was due to the age-old reason why stock prices move; news.
Notwithstanding chip shortages, increased competition, price hikes, and safety issues, the new orders figures from China dropped by 50% in May to 9,000 units, although this figure is disputed by JL Warren Capital's Junheng Li, who thinks its more like a drop of 30%. Either way, China is a critical market for Tesla and its distribution centre for the rest of Asia. That why the factory in Shanghai has the capacity to deliver 500,000 EV's per annum. If Chinese consumers are cooling on Tesla, it would be nothing short of a disaster, and it showed up in the share price.
Nothing nefarious going on here, just plain old sentiment on the back of data.
I understand perfectly that these examples and analysis are somewhat crude and that a more profound review might challenge my simple premise that there doesn't seem to be a strong correlation between share price movement and short interest, which I'm using as a proxy for securities lending. Academics, however, have done the work and reached similar conclusions. So what analysis are regulators conducting before they declare that short selling must be banned for a period of time and make such bold statements as the one quoted from ESMA in the first paragraph?
Regulators do not operate independently of the markets they oversee. If they did, without collaboration, practitioners would either be non-compliant or find ways around controversial regulations that could lead to the unintended consequence of additional risk. It's why new regulation typically begins with an extensive consultation period to get the 'buy-in' from the market and create the perception, real or imaginary, that those to be regulated have helped shape the very regulation to which they will subject themselves. And yet, when it comes to temporary bans on short-selling, there is no debate, discussion or consultation. All that comes after the event in bold statements from the likes of Nandini Sukumar.
I find it telling that both the UK and US markets did not ban short-selling last year. Perhaps they have conducted more analysis or read the academic research, or, better still, believe that short-selling is a valuable and positive contribution to price discovery and well-functioning markets at all times. And its well-functioning market that all regulators state is a primary principle. To take action that has been proved to widen bid /offer spreads seems to run counter to that principle. Rather than wait for the next event that throws markets into turmoil, why not ask regulators to account for their actions, define how 'appropriate and proportionate were measured or, at least, lobby for a consultation on the subject?