Short selling ban could hit derivatives business

A short selling ban imposed by the US Securities and Exchange Commission (SEC) could result in reduced equity derivatives and structured products business for dealers.

The SEC announced a temporary ban on the short selling of financial stocks this morning, following a similar move by the UK Financial Services Authority (FSA) yesterday. The SEC’s rules will remain in force until 11.59pm on October 2, while the FSA’s will last until January 16 (but will be reviewed after 30 days).

The two regulators imposed different rulings, and dealers are still getting their heads around the finer consequences of new regulations. However, there is widespread uncertainty around the SEC’s rules.

“The FSA gave an exemption for market makers, which they defined much more broadly than the SEC appears to have. It appears from the SEC’s statements that US investment banks will not be exempt from the short selling ban. This means they will be not be able to delta-hedge their positions for the duration of the ban,” said one global head of equity derivatives.

The lack of ability to hedge products sold to clients would mean banks would have to scale back much of their equity derivatives business, including the sale of some structured products, say dealers.

“We are hoping the SEC will come up with some guidance to say bona fine hedging is OK, but it is not in the initial documents provided by the regulator,” added the equity derivatives banker.

Meanwhile, in the UK, the FSA allows market makers to hedge their positions, enabling them to continue to conduct business more or less as usual. However, structured products that entail the client taking a short position via put options may not be allowed, suggest bankers.

“Structured products, such as those that include absolute return strategies, would not be available because their returns depend on a short selling component. We are looking at the structured products we are offering on a case-by-case basis to see whether they are affected by this ban,” says a head of equity structured products in London.

There will, however, be no impact on structured products already sold or trading positions in place. “There will be limited impact for existing positions as far as I can tell as short sales from the exercise or assignment of options held prior to the SEC order's effectiveness are allowed,” said a London-based equity derivatives strategist at a major bank.

Meanwhile, many dealers are still waiting on more information about the new rules.

"It could have some impact on derivatives volumes but it is hard to say to what extent until we get more clarity from regulators. However, as market markers, including options market makers, are exempt in the UK, this does not adversely impact businesses that hedge client flow," said Abhinandan Deb, equity derivatives researcher at Barclays Capital.

See also: SEC and FSA ban short selling on financials
Naked short-selling banned in Australia