Merkel's `Distortive' Short-Selling Ban Failed to Achieve Aims, IMF Says

Germany’s unilateral ban on some kinds of naked short-selling failed to achieve the government’s aim of keeping asset prices from falling and succeeded only in impeding markets, the International Monetary Fund said.

“Market efficiency and quality in fact deteriorated substantially following the introduction” of short-selling bans in Germany and other European Union countries, the Washington- based IMF said in a report published yesterday and posted on the fund’s website.

The ban by Chancellor Angela Merkel’s government, issued overnight on May 19 by the BaFin financial regulator, “did relatively little to support the targeted institutions’ underlying stock prices, while liquidity dropped and volatility rose substantially,” the IMF said.

Merkel invoked “a battle of the politicians against the markets” and labeled speculators “our adversaries” as her government prohibited naked short-selling of bonds, credit- default swaps on euro-area government bonds and stocks of German companies. The decree, made as European governments and the IMF hammered out a $1 trillion bailout package to arrest a debt crisis emanating from Greece, sent stocks around the world sliding. Parliament anchored the decree in law last month.

There’s no strong evidence that short selling led to falling prices during the crisis, the IMF said. Most of the “adverse market movement can be attributed to fundamental factors and to uncertainty due to partial or inadequate disclosures.”

‘Unnecessarily Distortive’

The report adds to criticism that the German regulation is too far-reaching and misses the point. The IMF said it favors a more harmonized approach to short-selling regulation in the EU as “go-it-alone approaches are unnecessarily distortive and inadequately effective.”

“The Finance Ministry doesn’t see the IMF report as a direct criticism of Germany,” ministry spokesman Bertrand Benoit said by telephone. “We made it clear from the beginning that we would be ready to modify legislation to bring it in line with EU-wide legislation.”

Credit-default swaps are derivatives that pay the buyer face value if a borrower -- a country or a company -- defaults. In exchange, the swap seller gets the underlying securities or the cash equivalent. Traders in naked credit-default swaps buy insurance on bonds they don’t own. Naked short selling involves selling a security without ever being in possession of it.

Sarkozy Joins In

While Merkel was initially isolated on the short-selling ban, French President Nicolas Sarkozy later joined her in calling on the EU to speed up curbs on financial speculation.

The EU plans to propose new rules on short selling next month, Financial Services Commissioner Michel Barnier said in June. The commission, the EU’s executive agency, is reviewing comments from industry groups before making any proposals.

The European Commission’s proposal is a “good first step towards a common framework,” according to the IMF.

“We agree with the Commission that short selling generally fulfills a valuable role in financial markets, and should be possible,” it said. Short selling “augments market liquidity, increases trading volumes and serves as a signal to discriminate perceived strong from weak firms or sovereigns.”

Still, effective supervision and enforcement as well as enhanced transparency, “margining” and collateralization should be employed to contain risks from market abuse and deliberate failures to deliver the shorted securities, it said.

The Association for Financial Markets in London, which represents banks including UBS AG and Deutsche Bank AG, said July 12 that the commission’s proposals to make investors disclose short positions at low thresholds are “unfair.”

To contact the reporter on this story: Rainer Buergin in Berlin at rbuergin1@bloomberg.net

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