Inverse ETFs have been one of the great inventions of the last few years, allowing investors to create short (i.e., negative) exposure to indexes within accounts that otherwise allow only investors to hold long positions—and they have proved invaluable in the 2008 equity bear market.

Yet suddenly inverse ETFs have had to cope with a fundamental change to the investing rules—the flood of short-selling restrictions that have been introduced in recent weeks by European regulators.

We have already seen the impact on a number of specialist inverse US ETFs by similar restrictions from the SEC, most recently covered on IndexUniverse in this report. In Europe, Deutsche Bank recently requested an exemption from its market-making obligations in its DJ STOXX 600 Banks Short ETF (XETRA: XS7S.DE) as a result of the short-selling restrictions, a move that implicitly halts new ETF creations.

Of course one of the many ironies in all this is that the new regulations—which are ostensibly being introduced to help investors and prevent downside pressure on the markets—are in fact removing from investors one of the few useful ways to hedge themselves, particularly in the financials sector. And, as the last week's market falls (and many similar previous episodes) have shown, removing the shorts has little effect in stopping price declines.

Temporary Truce? 

But with commentators in the UK, from archbishops to politicians, attacking short-sellers as "bank robbers", "spivs" and "speculators", it seems that the populist tide is still running strongly against those who suggest equities are overvalued. And so while a truce appears to have been reached for the time being between market participants and the regulatory authorities, it feels as though further hostilities could break out at any time, with short-selling bans potentially being extended both in time and to new sectors of the market. So it's worthwhile reviewing the rules in Europe as they stand, and to gauge the opinion of ETF market participants as to how this type of fund is bearing up.

An up-to-date summary of the short-selling restrictions is available at the dataexplorers.com Web site, under "regulations". What springs first to mind is the sheer complexity of the rules—covering different stocks on each exchange, with different reporting thresholds (as a percentage of the companies' equity), different periods for the rules to stay in force, different methods of reporting. The whole exercise smacks of a panic reaction by the respective authorities, with little thought given to the smooth running of the markets.

How does this affect European ETFs? At the latest count* there are 19 inverse equity ETFs on offer, shown in the table below (the Norway-listed XACT derivative bear is missing from the table). Only db x-trackers has ETFs offering inverse equity sector exposure. The other inverse ETFs on offer—from db x-trackers, XACT, Lyxor and SGAM—give negative exposure to broad country indexes (DAX, CAC 40, FTSE 100, S&P/MIB, the Swedish large-cap index and the Oslo OBX Index) or to the pan-European large-cap DJ Euro STOXX 50 Index.

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