GameStop | Short Selling | Capital Markets Union
For the past two weeks, the world has been fixated with the changing fortunes of GameStop, and how those have played out in the world’s media. We have seen what looks like at times a populist, retail-led revolution squaring up to the hedge fund community, and potentially challenging what we regard as norms within financial markets. Whilst I would not want to comment further on the merits of the arguments on either side of this debate, some of the issues that recent events have highlighted are obviously very pertinent to our markets. Also, as we look at how events have unfolded, it is important that we reflect on what this means for the wider development of capital markets across Europe, and what lessons we can take from GameStop.
The first point that we should consider is exactly what has happened here. Whilst there are novel features around the market participants involved (in terms of the participation of retail or so-called ‘day traders’), GameStop is no more than a simple short squeeze. We have seen on numerous occasions in the past where short sellers have been forced back by the weight of long-only buy-side investors, who have fundamentally disagreed with the negative sentiment being expressed around a stock by short-side investors. Inevitably, GameStop and in particular the direct involvement of retail participants has triggered wide ranging and at times very polarised debates. If we pause for a moment though, it is important to put GameStop into context here, especially as we have seen limited instances of so-called ‘swarm trading’ appearing in European markets more recently. We should not forget that short selling and securities lending are highly regulated and very transparent markets in Europe. Typically, institutional investors lend securities to prudentially regulated banks and principal borrowers to support several crucial elements around market liquidity, including short selling and portfolio hedging. Through the provision of SFTR, the regulatory community in Europe has access to timely and high quality market data that will allow them to take precipitous actions as necessary. In its 2019 report entitled ‘Undue short-term pressure on corporations’, ESMA stated:
“short selling is a legitimate strategy subject to a number of obligations and constraints established in the Short Selling Regulation. Moreover, there does not seem to exist a clear link between short-selling strategies and the typical strategies of shareholder activists. Nonetheless, the Short Selling Regulation provides for a) prohibition of naked short-selling of shares; and b) transparency requirements, both towards regulators and the public…..”
“….Furthermore, ESMA has considered the general arguments in relation to the impact of short-selling and securities lending practices and their potential link with short-termism. Nevertheless, ESMA points out that short-selling and securities lending are key for price discovery and market liquidity. Moreover, ESMA is not aware of concrete evidence pointing to a cause-effect connection between these practices and the existence of undue short-term market pressures.”
Notwithstanding some of the extreme rhetoric around short selling and securities lending, there is no doubt that key elements of the regulatory community recognise the importance of a well-run, appropriately regulated, and transparent securities lending market to facilitate the smooth functioning of the wider capital markets. GameStop does however raise some important questions as we think more broadly about the wider development of the Capital Markets Union (CMU) here in Europe.
The most immediate and perhaps most intriguing issue is the role of retail investors, and the way technology is providing immediate and low-cost access to financial markets. This democratization of financial markets poses several questions. Some commentators have suggested that retail investors should be barred from contemplating some of the more complex products associated with market volatility. Whilst this may appear expedient from a political perspective, this would fundamentally be flawed, and raise the possibility of further divisions between the traditional financial markets ‘elite’ and their counterparts, and the new populist day traders. Part of opening-up of markets to retail investors must include a commitment from regulators and politicians to empower its citizens through the development of greater financial fluency, in the form of better education that will build the trust that is needed for these markets to reach their full potential.
On 24 September 2020, the European Commission adopted a new CMU 2020 Action Plan, which aspired to develop a CMU for people and business. In addition to outlining a desire to make the EU an even safer place for individuals to save and invest, one of its key commitments was to look at the possibility of requiring Member States to promote learning measures to support financial education. Some of the anectodical evidence coming from the GameStop story, where retail investors have lost life savings as the stock has fallen back in more recent days, highlights the importance of advocating for such broader education.
The next twelve months will see key elements of the regulatory framework in Europe, including MiFID/MiFIR, Short Selling, and Market Abuse all coming up for review. Whilst GameStop will perhaps soon be forgotten, the signals that it has sent across the investment community are both wide-ranging and far-reaching. Greater and more direct action from retail investors looks like something that is here to stay, and it is therefore crucial that these changes are embraced as we all look at these important pieces of legislation with fresh perspectives over the coming months.
Andrew Dyson, CEO