PORTFOLIO STRATEGY

+ 44 207 888 0908 Mark.buchanan@credit-suisse.com

Mark Buchanan

+ 44 207 888 2677 Jonathan.tse@credit-suisse.com

Jonathan Tse

Portfolio Strategy
Impact of Short Selling Bans in Europe
Market Commentary

+ 44 207 888 4418 Drew.vincent@credit-suisse.com

Drew Vincent

3 October 2011

Key Points
Effective August 12th regulators in Belgium, France, Italy and Spain introduced short selling bans on financial stocks. The bans appear to have done little to halt the slide in share prices or dampen volatility relative to peers. They may also have contributed to significantly reduced liquidity in affected financials and a widening of bid-ask spreads, increasing the cost of trading. These effects may partly explain why other major European countries have thus far failed to follow suit.

Belgium, France, Italy and Spain Introduce Bans in Response to Euro Debt Crisis Volatility
On August 11th regulators in Belgium, France, Italy and Spain introduced short selling bans on financial stocks 1 following a period of high volatility linked to the euro debt crisis. The bans which according to ESMA were introduced in order to restrict the benefits that can be achieved by spreading false rumours 2 became effective on August 12th. With the exception of Belgium, they were originally intended to last 15 days only, but these dates have since been extended (see Exhibit 1). Exhibit 1: Ban Summary
Country Belgium France Italy Spain Proposed End Date Indefinite. Until further notice and for a period that cannot go beyond November 11th. November 11th. Indefinite No. of Stocks 4 9 28 13

Short Selling Bans Return to Europe

Source: Credit Suisse Portfolio Strategy

Exhibit 2: A Decade of Volatility

100 90 80 70 60 50 40 30 20 10 0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Septem ber Attack in US Greece / Euro Debt Crisis Dot-com Bubble Bursts Global Financial Crisis

Dj vu All Over Again?

This is not the first time regulators in Europe have banned short selling in response to a spike in volatility. For example, in May 2010 Germany introduced a temporary ban on naked short selling of financials; and, in September 2008 at the height of the global financial crisis the UK temporarily banned short selling in financials, and was quickly followed by other major European countries and the US. Our analysis of these bans for example Short selling - What's going on in Europe? and Examining the Wake of the Short Sale Restriction suggests that not only do short selling bans not stop share price declines, they also tend to result in reduced liquidity and wider bidask spreads, increasing the cost of trading.
US (VIX) Europe (V2X)

J.P. Morgan Acquires Bear Stearns

Source: Credit Suisse Portfolio Strategy, Jan 3, 2000 to Sept 2, 2011

In this report we again focus mainly on performance, liquidity and bid-ask spreads, using non-financials in the affected countries as well as nonbanned financials in Germany, the Netherlands and the UK for our control groups. Our findings may explain why other major European countries have thus far failed to follow suit.

1
2

For further information on short selling regulations please see www.esma.europa.eu/data/document/2011_39.pdf. ESMA promotes harmonized regulatory action on short selling in the EU. European Securities and Markets Authority. 11 August 2011.

(212 (

PORTFOLIO STRATEGY

Banned Financials Underperform Non-banned Financials

Selling Pressure Comes from Long Sellers
As shown in Exhibit 3, the short selling ban appears to have done little to halt the slide in share prices. Following an initial period of outperformance when short sellers reduced their positions, banned financials are now 10.4% lower than when the ban was introduced versus a 4.4% decline in non-banned financials. This is despite a significant shift in the amount of stock on loan a proxy for short interest away from banned names towards non-banned German financials, and implies that long sellers (as opposed to speculative short sellers) are forcing prices down. This point is reinforced in Exhibit 4 which shows that since the ban was introduced most of the biggest fallers have been banned stocks. Exhibit 3: Performance of Banned / Non-Banned Financial vs. % Change in Short Interest of Banned / DAX Financials
130% Normalised Performance
Effective date of ban

Exhibit 4: Performance of Banned vs. Non-Banned Financials Post Ban*

40%
MI IM EMG LN

80% Chng in Stock Loan %

20% Performance

120%
(vs. close Aug 11th)

110% 100% 0% 90% 80%

11 -A ug 16 -A ug 21 -A ug 26 -A ug 31 -A ug 1Au g 6Au g 5Se p 10 -S ep 15 -S ep 20 -S ep

(vs. Aug 11th)

40%

MAP SQ SAN SQ HSBA LN

0%

-20%
GLE FP BVA SQ BNP FP

-40%

-40%
100 1,000 10,000 100,000 1,000,000

DAX Financials vs DAX Stock Loan % Banned Financials Perf

Banned Financials Stock Loan % Non-Banned Financials Perf

Log Market Cap ($m) Banned Financials Non-Banned Financials

Source: Credit Suisse Portfolio Strategy, Aug 12, 2011 to Sept 20, 2011 * Caja De Ahorros Del Medi (CAM SQ), a banned stock which has fallen ~60% since the ban was introduced is excluded from this chart.

Source: Credit Suisse Portfolio Strategy, Aug 1, 2011 to Sept 20, 2011

Exhibit 5: Turnover (Volume) in Banned Financials vs. Control Groups

Banned Financials Non-Banned Financials Non-banned (Belgium, France, Italy, Spain)

Liquidity in Banned Financials Shrinks

The ban may have contributed to reduced liquidity in banned names (see Exhibit 5). Median turnover in banned financials is 43% down versus median turnover from January 3rd to August 11th, 2011. This compares to 22% down for non-banned financials and 1% down for non-financials in the same countries. The drop in turnover is even more pronounced versus the pre-ban crisis period in August, and is only partly explained by share price declines.

Liquidity Dries Up

Time Period

Median Turnover (Volume) for Ban Period vs. Median Turnover (Volume) from Jan 3rd Aug 11th th

-43% (-34% )

-22% (+26%)

-1% (+1%)

Source: Credit Suisse Portfolio Strategy, Jan 3, 2011 to Sept 15, 2011

PORTFOLIO STRATEGY Relative Liquidity of Non-Banned Financials Increases

The ban appears to have contributed to a relative increase in the liquidity of non-banned financials (see Exhibit 6), and is likely linked to traders seeking alternative hedges to long positions, as highlighted in Exhibit 3. Exhibit 6: Turnover of Banned vs. Non-Banned Financials
220%
(vs. Median Turnover from Jan 3rd to September 16th

200% 180% 160% 140% 120% 100% 80% 60% 40% 20% 0% 01-Jun 08-Jun 15-Jun 22-Jun 29-Jun 06-Jul 13-Jul 20-Jul 27-Jul 03-Aug 10-Aug 17-Aug 24-Aug 31-Aug 07-Sep 14-Sep

Normalised Turnover

Non-Banned Financials

Banned Financials

Source: Credit Suisse Portfolio Strategy, Jun 1, 2011 to Sept 15, 2011

Bid-Ask Spreads Widen vs. Non-Banned Financials

As well as reducing liquidity, the ban may also have contributed to a widening of bid-ask spreads. This is evident in Exhibit 7 which shows that average spreads in banned and non-banned financials diverge strongly at the point where the ban is introduced, but continue to track volatility well. As shown in Exhibit 8, the basis point change in average spreads for banned financials does not simply reflect the decline in share prices. Exhibit 7: Average Spreads of Banned and Non-Banned Financials vs. Volatility
30 Average Spread (bps) 25 20 15 10 5 0
15-Jun 22-Jun 29-Jun 1-Jun 8-Jun 6-Jul 13-Jul 20-Jul 27-Jul 3-Aug 10-Aug 17-Aug 24-Aug 31-Aug 7-Sep 14-Sep

Bid-Ask Spreads Widen

Exhibit 8: Tick Size vs. Actual Spread for Banned Financials

60

30 Average Spread (bps) 25 20 15 10 5 0

15-Jun 22-Jun 29-Jun 1-Jun 8-Jun 13-Jul 20-Jul 27-Jul 6-Jul 3-Aug 10-Aug 17-Aug 24-Aug 31-Aug 7-Sep 14-Sep

50 40 30 20 10 0 VSTOXX Level

VSTOXX

Banned Financials

Non-Banned Financials

Tick Size

Actual Spread

Source: Credit Suisse AES Analysis, Jan 3, 2011 to Sept 16, 2011

Source: Credit Suisse AES Analysis, Jan 3, 2011 to Sept 16, 2011 3

PORTFOLIO STRATEGY

Ratio of Banned vs. Non-Banned Volatility Was Falling Pre-Ban but has Risen Again Post-Ban
Since the ban, there has been a clear change in volumes and volatility of the financial stocks, which now behave more or less in line with other stocks 3 Thierry Francq secretary general of the AMF. As we have seen, volumes in banned financials have dropped substantially more than non-banned financials (see Exhibit 5). As to whether the ban has reduced the volatility of banned financials versus their peers, we can see from Exhibit 9 that this is not the case. Exhibit 9: Volatility Ratio - Banned vs. Non-Banned Financials*
220%
4) Post-ban, convergent trend reversed.

Relative Volatility Increases

200%
2) Dramatic increase due to euro crisis.

180%
1) Banned financials volatility ~30% higher than non-banned financials.

Ratio

160%

140%
3) Strong convergence towards pre-crisis ratio as overall volatility jumps.

120%

100%
03-Jan 17-Jan 31-Jan 06-Jun 20-Jun 04-Jul 14-Mar 28-Mar 11-Apr 14-Feb 28-Feb 25-Apr 18-Jul 01-Aug 15-Aug 29-Aug 12-Sep 09-May 23-May 26-Sep

Source: Credit Suisse AES Analysis, Jan 3, 2011 to Sept 27, 2011 * Volatility is calculated using 15min intra-day returns.

For most of the year, the financial stocks that would eventually be banned traded with approximately 1.3 times the volatility of their peers. While the recent Eurozone panic saw this difference increase dramatically (peaking at 2 times around mid-July), towards the end of July as overall volatility increased - the volatilities of these financials and our control group began to converge, the ratio reaching pre-crisis levels immediately before the ban. However, following the introduction of the ban, the stocks affected have become relatively more volatile again, reversing what had been a convergent trend.

Hughes, Jennifer. Short sellers remain calm despite bans FT.com. The Financial Times. 23 August 2011. 4

PORTFOLIO STRATEGY

Conclusion
At times of extreme volatility, it is easy to understand why regulators react by introducing short selling bans and blaming false rumours for driving prices down. However, as illustrated above, the short selling ban appears to have done little to halt the slide in share prices or dampen volatility relative to peers. In fact, the affected financials have seen bid-ask spreads widen and have suffered a significant drop in liquidity since the ban was introduced, increasing the cost of trading. While short selling bans represent a tempting and politically expedient option, closer inspection demonstrates that in fact they do more harm than good. Perhaps it should come as no surprise that they have not seen more widespread use.

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