CBFL Seminar: The Regulation of Speculative Wars: Short-selling and short-squeezing by Dr Vincenzo Bavoso, University of Manchester

On 27 August 2024, the Centre for Banking and Finance Law (CBFL) welcomed Professor Vincenzo Bavoso, Professor of Commercial Law, University of Manchester. Associate Professor Sandra Booysen, Director of CBFL, moderated the Professor Bavoso’s seminar titled “The Regulation of Speculative Wars: Short-selling and Short-squeezing.”

Professor Bavoso began with a brief explanation of the meme stock phenomenon as was widely reported in the case of GameStop in January 2021 and more recently with AMC shares. The questions raised by the GameStop speculative wars formed the inspiration for the inquiry undertaken in the present project. These involved speculative wars between institutional investors and retail investors acting collectively in the tug-of-war of short-selling and short-squeezing the relevant shares.

He then explained the differences in the mechanics of covered and uncovered (also known as “located”) short-selling and their attendant risks and effects to the market participants in the picture. Uncovered short-selling, where the short-seller need not borrow the shares but merely “locates” shares to meet the sale in the belief that they will be “reasonably available” had the potential to create ghost shares, where shares traded exceeded the available shares, which in turn tended to lead to temporary failures to deliver. Nevertheless, this was in principle justified on the grounds of the resulting liquidity of shares, on the assumption that bona fide market makers would typically be able to correct the failures to deliver.

Short-selling therefore involved the conceptual trade-offs of price discovery and market efficiency on the one hand, and the potential for volatility and financial instability on the other. Problems could, however, potentially arise where failures of delivery were in effect “covered up” by market participants. Professor Bavoso then elucidated the regulatory approaches taken in the United States in particular Regulation SHO and the Securities Exchange Act 1934, assessing how they have been used in regulation in both normal and abnormal market contexts. In doing so, he queried whether the approach indicated a shift to more regulation instead of market-driven practices. Nevertheless, it appeared that the circuit breaker mechanism did not succeed in preventing the massive devaluation of GameStop shares. He also observed that proving an intention to drive down prices is evidentially difficult, which raised the question of whether a different regulatory approach was needed. Also discussed was the bona fide market-making exception in Rule 203(b) of Regulation SHO and its potential breadth and applicability in practice.

Professor Bavoso then highlighted a number of proposed legal reforms to close the gap in regulating speculative wars between short-sellers and short-squeezers. Chiefly, it was proposed that an enhanced circuit-breaker be put in place which better rewards informed traders who are the first to move in the market, but which caps exposure and systemic risk.

Thereafter, the session moved into an engaging time of Q&A at the Lee Sheridan Conference Room. Comparative analysis was a theme of the discussion, and the differences in hedge fund and investor activism and regulatory attitudes in the European and Asian markets were raised and thoroughly debated. Similarly, alternative regulatory approaches were discussed, including in the treatment of short selling in various Asian jurisdictions. Finally, the role of hedge funds and their disciplining effect on the one hand and the potential destablising effect on the market on the other was discussed.

The presentation was on one part of an ongoing project undertaken jointly by Professor Bavoso and Dr Michael Galanis, Senior Lecturer in Company Law, University of Manchester with the funding of the British Academy and the Leverhulme Trust. Ryan Tsivitse (University of Indiana) provides research assistance. The results of this project will be eagerly awaited by all working in capital markets regulation and will undoubtedly be of great benefit to regulators and legislators across jurisdictions seeking to reform their respective legal frameworks.

Professor Bavoso’s profile may be found here.

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