The global financial system has experienced a month of unprecedented anarchy as the Covid-19 pandemic is spreading and bringing western capitalism to its limits. Companies and investors are turning to stock exchanges, amid one of the most tumultuous periods in market history to borrow money, buy or sell assets, and limit losses in their holdings. Yet all this, without a clear understanding or prediction as to when Covid-19 will be over.
Many countries have introduced major restrictions on the operating hours of public institutions, public events and limited our free movement. Some have closed their borders, and many require a permit for people to even step out of their houses. The situation is serious and naturally, a majority of companies are bracing for the worst, with some either filing for insolvency or attempting to open new lines of credit in order to survive the upcoming months. As of today, we lack any clear assurances as to when we will be able to return to our work (the author is situated in Denmark) or when we will be able to travel. Despite all these facts, some institutions continue to operate without any restrictions and in my opinion cause more harm than good. Specifically, the stock exchanges continue to rattle our financial systems and companies every single day over and over without any major protest from the companies themselves or the governments.
Professor Enriques in his recent blog post discussed why the stock markets should remain open, while taking an example of the Italian stock market and supporting the decision of the Italian government to keep the Borsa Italiana open. In this paper, I express a different opinion and as such I argue that the stock exchanges should have been closed for some time now. I have written on this issue in another blog post, but this piece is expanding on my previous arguments while reflecting on Professor Enriques’s.
The central argument in my earlier post evolves around the lack of adequate predictions which ultimately render the stock exchanges unreliable and harmful to the market. Stock exchanges have traditionally facilitated capital, by providing a marketplace where securities can be traded after they are offered to the public. The evaluation of the securities was based on the publicly available information in regard to the economic and non-economic performance of corporations combined with demand and offer (in simplified terms). Professor Enriques emphasized the importance of liquidity and the risk of illiquidity in case stock exchanges would be closed down. Even though I fully agree that by closing the stock exchanges, we are going to shut down one source of capital, yet with the same breath, I would add that the risk of illiquidity is already very much present. The IMF has already stipulated that we might face ‘a recession at least as bad as during the global financial crisis or worse.’
Equity markets are on course for their worst quarterly performance since the 2008 financial crisis. The FTSE 100 in London is set to register its worst quarter since the 1987 stock market crash and the S&P 500 has the volatile trajectory of a flying butterfly. March was the S&P 500′s most volatile month ever, according to Bespoke Investment Group. During March, the benchmark index averaged a daily move, in either direction, of more than 4.8%. Neither sellers, nor buyers are able to make any informed decisions. Stock markets are essentially a reflection of investors’ confidence which affects the actual sentiment and investment as much as access to funding. As long as investors lack confidence in stock exchanges, there will not be any capital flow and thus the risk of illiquidity will materialize no matter what. Only high-risk investment entities will be willing to invest, leaving all corporations exposed to aggressive attacks.
We have experienced a lot of hot air on the stock exchanges before and we have tolerated it as with time the market and its participants adjusted the prices or the information. However, today this is not the case. The volatility of the stock market is impairing efficient price formation. The simple explanation for this is that despite technological advancements and the use of algorithms, neither the market participants, nor the algorithms have taken into consideration the situation that we are facing at this moment, as there is no real precedent. Algorithms themselves are built upon models, which are currently non-existent and as a result we are left with erratic stock markets.
It is undisputable that closing the stock markets will limit companies’ access to capital for some time. But leaving the stock exchanges running is far worse, predominantly for the companies. Even modern portfolio theory is hard to apply at this time as there is no place to diversify, neither geographically nor by asset class. Covid-19 is pounding economies all over the world. We have not yet experienced a similar situation, where all markets have been involved. Thus, I must ask what is the value that the stock exchanges offer at this point in time?
I agree with Professor Enriques that many states actually lack the power to shut down their stock exchanges, which is also telling. This is the case predominantly due to the historical development of stock exchanges as self-governing organizations. However, this is the time that the stock exchanges should themselves recognize that their operation becomes purely self-serving, highly speculative and open for market manipulation that they will be unable to oversee or punish. There are various governance tools that have halted trading on individual stock exchanges several times over the past weeks. What will it take to hit the pause button for a couple more weeks or months? We might need an economist to answer this question.
Another concern that needs to be addressed is whether shutting down one stock exchange (ie London or NYSE) would protect companies and market participants or just cause more damage and volatility. Since the markets are essentially interconnected, closing down stock exchanges would need to be a coordinated action between the major stock exchanges. Moreover, we would not only need to halt trading on stock markets, but also on derivatives markets. Effectively, we would need to hit the pause button on all major markets trading all equities and their derivatives.
In conclusion, there are legal and economic rationales on both sides of this discussion. There are also many questions to which we do not know the answers. Yet, somehow I expect that the only beneficiaries at the end of this chaos will be hedge and vulture funds that continue to bet against the market and the companies, and rightfully so, as the market and its self-governing institutions fail to protect their participants.
Alexandra Andhov is an Assistant Professor at the University of Copenhagen Faculty of Law.