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Stock lending a cause for concern

Concerns over recent shorting, especially from arbitrageurs who have borrowed stock, are valid so may I propose that stock lending is banned?

Other than for nominal adjustments for market-makers on overnight positions, analysing the situation suggests that those doing the stock lending in the first place are not doing themselves any favours anyway.

Why do arbitrageurs borrow stock? They do it to sell short in the anticipation of buying back later at a lower level – to make a profit.

During volatile times in general or for a specific company situation (of which many can be named presently, sadly), it increases volatility and uncertainty. Price falls can become inevitable because of simple supply and demand arguments.

It can be argued, however, that those who lend stock are the losers. They receive a small “premium” for the privilege but if the speculation works, then the value of their investment is falling, their management fees diminish and their comparative performance is poorer.

This helps to exaggerate the declines by giving the market the impression that genuine sellers are “dumping” a holding.

However, in effect, the market is unaware that the quantity of shares being traded suggests that in excess of 100 per cent of equity in that company is in existence at the point of sale – or at least that is the impression.

A ban would curtail the false market and individual price movements would be less volatile as traders would have to balance their books by acquiring stocks in the market to cover their shorts within a limited time span. This is likely to lead to a more orderly market.

Derivatives already exist but at least these indicate to the market the total quantity of stock being traded and in existence rather than a perception of an exaggerated unknown extra quantity.

“Shorting” would still happen but those doing so would be obliged to cover their positions in the very short term to meet market obligations.

Philip Milton

Barnstaple, Devon

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