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Critical test for market regulators as bots run wild and short sellers smell blood

Phil Carden, a former Macquarie executive director who is currently chief investment officer of Carden Treasury Corporation, a boutique global bond investment manager in debt markets and foreign exchange, says the panic in debt markets is palpable.

“The way the markets are pricing corporate debt is that they believe there will be so many defaults that the world is coming to an end, we might as well live in a tent, which I don’t think is right. So there’s a lot of panic and therefore exceptional buying opportunities,” he said.

UniSuper's John Pearce tries to curb short selling.

UniSuper’s John Pearce tries to curb short selling. Credit:

Broking houses have waded in with their own predictions.

Macquarie told clients, “prepare for dividend cuts and suspensions” as it cautioned that the cuts could well be at similar levels as the global financial crisis. It also noted that spikes in the corporate credit spreads raised concerns of the ability of companies to refinance debt.

Goldman Sachs told its investors Australia’s economic growth in 2020 will be the worst since the Great Depression, while ANZ said in a research note the “reality is economic policy simply cannot offset the demand loss that comes from widespread economic shutdowns”.

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Given the small improvement in the equities market since the Reserve Bank’s big announcements on Thursday and the expectations of a big package to be released by the Morrison Government, ANZ has a point.

Carden believes instead of quantitative easing and buying government bonds, which won’t help people pay their mortgages, the RBA should give direct loans to the Treasury at zero interest rates for 50 years with terms and conditions attached. Those conditions would include that the loan and money can only be used for the creation of productive infrastructure that earns income, to stimulate jobs.

The problem is fear. Everyone is afraid. It began as a global health scare that has morphed into an economic disaster with jobs threatened, businesses face extinction, retirement savings slaughtered and no one knows how long it will last.

Until there is certainty, the financial market rollercoaster ride will continue. It is why the regulators need to step up.

During the global financial crisis short selling was banned in most countries.

Italy, France and Belgium and South Korea have again stepped in and imposed short selling bans in a bid to quell markets.

Short selling is made possible by financial institutions lending their stock to hedge funds who then use the borrowed shares to force down share prices.

It is a technique used by traders to make profits out of a falling market.

UniSuper decided to take the lead on Monday and announce it would stop lending its stock until further notice. John Pearce, chief investment officer, said he did it because he believed that restricting the ability to short sell was in the best interests of promoting an orderly market.

A few other funds have followed his lead, but not enough to make a difference. It raises the question whether the corporate regulator, ASIC, should step in.

ASIC has been sounding out various funds, no doubt in the hope they will do it themselves as a natural limiter to short selling. But sometimes that requires a regulatory nudge rather than waiting for a market response.

In the past few weeks short selling hasn’t been a massive driver of the Australian equities market but hedge fund activity is on the rise.

According to shortman.com.au, the top 10 shorted stocks include Galaxy Resources, where 20 per cent of the stock was shorted, followed by Syrah Resources, Orocobre, Metcash and Inghams Group at 12.8 per cent.

A few financials stocks have also popped onto the hedge fund radar including Perpetual at 8.85 per cent, Bank of Queensland at 8.2 per cent, Bendigo at 7.5 per cent, AMP at 6.5 per cent and IOOF at 5.51 per cent.

Globally, the numbers are clear. Global custodian giant, State Street, which has an inside running on stock lending flows, wrote a report on March 17 titled “Short sellers come out to play”.

The report said hedge fund managers have upped their short selling activity and share borrowings had spiked in every sector globally.

It said a particular concern was the financials sector on the basis short positions in financials were at the highest level in three years and rising sharply.

“Institutional investors are overweight and aggressively selling out of those positions too,” the report said. It said real estate had also seen a big spike.

Short selling, margin lending and algorithmic trading, all add to market volatility.

After a long bullrun, followed by the recent violent falls, nothing is more certain than margin calls, which will result in another leg down in the market.

Sharemarket volatility has been amplified by algorithmic trading. On Monday, ASIC decided to force some market participants who engage in algorithmic trading to reduce trading by 25 per cent after the previous week saw a massive surge in the volume of trading, which put a strain on the back offices of some broking firms.

Since then volumes have settled down but the regulator will need to consider more draconian measures if volatility returns.

Meddling in markets is never welcomed by free marketeers who argue that high frequency trading, algorithmic trading, short selling and margin lending adds to market efficiencies and liquidity.

That may be so but when markets are in freefall and the economy is hanging by a thread, the regulators need to step up to the plate and rein it in.

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