Banning short selling is a bad idea

There have been calls from several broking houses to follow the examples set by some European and Asian markets and either ban or further restrict short selling on the Hong Kong stock market.

A ban on short selling would be short sighted and detrimental to the market and investors generally.

To begin with, short selling in Hong Kong is already tightly regulated:

1. only designated securities may be short sold - all large cap liquid stocks

2. naked short selling is illegal - if you want to sell short, you have to borrow the shares from someone else first

3. short selling requires disclosure - short sales have to be reported on a daily basis and insiders have to publicly disclose short positions

At the risk of stating the obvious, short selling provides many benefits including:

1. a more liquid market with reduced spread - not only due to short selling in expectation of falling share prices but also short selling for abritrage purposes, the smaller spreads actually help long only investors

2. reduces the potential for market manipulation (although this is more of an issue in smaller cap stocks which are not eligible for short selling anyway)

3. reduces the risk of the market becoming over valued (or at least offers the potential to reduce the extent to which the market may become over valued) . Put differently, short sellers give long only investors an opportunity to buy at better price than would otherwise be available

4. provides the potential for support when the market has fallen - at some point the borrowed shares have to be returned to their owner which will require the short seller to go out and buy (or repurchase) the necessary shares. Every short seller becomes a buyer at some point

5. produces a more transparent market and incentivises companies to be more open and honest - allowing short selling gives investors an incentive to look for problems with a company and to invest accordingly

Jake van der Kamp's piece in this morning's SCMP made the excellent point that professional shorts produce some of the most thorough investment research and that such research goes a long way towards exposing issues with listed companies and protecting investors.

Also Sprach Analyst made the valid point that banning short selling simply does not work.

Suggesting that short selling should be banned is nothing new. Hopefully the government and the regulators will ignore the calls.

The really really depressing thing about the calls for a ban on short selling is not the general ignorance that is implicit in such calls, but that it is brokerage houses that are supporting them. These people should know better.