Stock Exchange Shutdowns in the Time of Coronavirus

If stocks were still traded in pits, stock exchanges would have been shut down in China, Korea, Italy and possibly elsewhere a while ago. A bunch of men shouting and feverishly passing each other sheets of papers would have spread coronavirus faster than the now infamous Korean sect.

But stock exchange trading was automated everywhere long ago, including at the Borsa Italiana in Milan. Nowadays, the only virus that can be transmitted by trading shares is panic selling. Is that an even better reason for shutting down stock markets, as some high-profile Italians politicians, including former Prime Minister Matteo Renzi, suggested last Sunday? 

It is reassuring that the Italian Government ignored the suggestion and even more reassuring that in a statement on Sunday the Italian securities regulator, Consob, appealed to reasonableness by reminding everyone that ‘[t]he trading halt of all stock market negotiations … would be a decision that would switch off the price indicator without removing the causes, generating market problems that are not easy to solve in the immediate future’. In other words: a stock exchange shutdown is the financial equivalent of getting rid of the thermometer when it signals fever: the only outcome is that it becomes more difficult to understand how serious the flu is and how it is evolving.  

And there is more: a stock exchange shutdown means putting more pressure on other financial instruments whose prices are correlated to that of Italian shares. Think of an investor who holds both Italian equity and Italian Treasury bonds in their portfolio. Given the greater impact of coronavirus in Italy than elsewhere, they might want to reduce their exposure to the country. If they were not allowed to sell the equity, to compensate for that they would sell more Treasury bonds, thereby contributing to the rise in their interest rate. Should Italy then also ban Treasury bond trading? Treasury bonds are traded outside Italy as well. A shutdown limited to domestic trading venues would only drain the bonds’ liquidity and hence make it much more onerous for the state to issue new bonds (something the Italian state does every few weeks). It would thus lead to the Government (hence, Italian taxpayers) having to pay higher interest rates in attempting to stopping downward speculative pressures on the equity market. To put it another way, attempting to curb the losses of the minority of Italian citizens who are invested in shares [1] would be at the expense of taxpayers generally. 

Additionally, the result of shutting down the stock exchange is to make the savings of those who are invested in it unavailable at a time of emergency, which is exactly when savers/investors may need to convert them into cash. This would be true not only for those who have bought shares directly, but also for those who have done so via mutual funds: how can an asset manager accept withdrawal requests if it can’t sell the assets in the fund’s portfolio and it is impossible to determine their value? In all likelihood, the asset manager would make use of its power, according to the contract with the unitholders, to suspend withdrawals until the stock exchange reopens.

Finally, the most intractable problem with shutting down exchanges is the fact that sooner or later they have to be reopened. In the present circumstances, for how long should the Italian stock exchange be closed? The problem being coronavirus, a few days would make no difference. Should they stay closed until the 3rd of April, like Italian schools? Does that sound too early? At the time of post-Lehman temporary bans on short selling (2008-09), Consob’s commissioners were periodically convened to decide whether to extend them. They repeatedly renewed them, in the fear that, otherwise, Consob would be held politically liable should downward speculative pressures resume. The dynamics would be the same today. It would be difficult for Consob, should positive developments in the fight against the virus and in economic conditions not materialise soon enough (as everyone hopes), to decide that trading should resume. 

Hence, the shutdown could go on for weeks and weeks. If you suppress investors’ liquidity needs for so many days, the downward pressure once the stock exchange reopens will be even stronger. Worse, once it becomes clear that the Italian stock exchange may shut down for weeks in the case of an emergency, investors, both Italian and offshore, would have to factor in that new illiquidity risk, which will make it less attractive to hold Italian shares and will therefore require investors to rebalance their portfolios: again, when the market reopens, this additional reason for selling would increase the downward pressure on prices. In addition to the temporary liquidity shock, the demand for Italian shares would go down for the longer term as well, raising Italian firms’ cost of capital.

In truth, however, at least in Europe all of this is financial regulation fiction: as Consob’s statement clarified, the regulator lacks the power to shut down the entire stock exchange. Even a shutdown through an emergency law by the Government would be unlikely to apply to trading activity on non-Italian trading venues, where Italian shares could well continue trading: an extraterritorial ban would likely be against EU rules, impossible to enforce, or both. The only effect of such an emergency law would thus be of reducing, but not halting, trading. That would have a strong negative impact on liquidity, would increase volatility, and raise the cost of executing transactions. The symptoms of panic selling would still be visible and the lower trading volumes would even amplify them. To conclude, a stock exchange shutdown would be a remedy worse than the disease.

This post is the translation of an op-ed published in the Italian daily il Foglio and available (behind paywall) here.

Luca Enriques is Professor of Corporate Law at the University of Oxford. Between 2007 and 2012 he was a Commissioner at Consob.

[1] The Italian pension system is pay-as-you-go and Italian pension funds’ exposure to equity (globally) is negligible, as annual reports of the Italian pension funds regulator show.