I saw a brief article today in the WSJ regarding conversations that are taking place about possibly restricting the ability to short stocks in the U.S. I was extremely fortunate to be leading Invesco’s quant group during the Great Financial Crisis when the U.S. last restricted short selling. We were managing a series of products that utilized shorting techniques, and the restrictions were harmful, as we had about $3 billion in AUM in those strategies. I felt that it was a mistake back then and I continue to believe that it would be a mistake once again.

As a reminder, when selling a stock short, investors are hoping to sell high and then buy lower. Typically, an investor taking a short position does not own the shares prior to the transaction, but borrows the stock through a prime brokerage relationship from another investor. The risk to the short seller is that the security’s price increases, instead of falling, that triggers a loss when the investor must buy it back at a higher cost. There is also a cost to borrow the stock that is to be shorted. Depending on the demand for that issue, the rebate rate can be quite high. An investor needs to have a fairly high conviction that the price fall will exceed the cost to borrow.

I believe, as do many market participants, that the ability to short equities creates a more liquid and efficient market. There are many academic papers that support this claim. ““We shouldn’t be banning short selling,” Securities and Exchange Commission Chairman Jay Clayton said Monday in an interview on CNBC. “You need to be able to be on the short side of the market in order to facilitate ordinary market trading”” (WSJ). James Overdahl, the SEC’s Chief Economist from 2007-2010 was recently quoted as saying “what we found was, on net, it was harmful. There were many unintended consequences”. We have enough to be worried about at this time. Let us not had more hurdles.