Powerful fund managers have suggested a ban on short-selling during rights issues in a move that could anger the investment banks that guarantee company cash-calls.

The Association of British Insurers (ABI), whose members own more than a fifth of the UK stock market, suggested that underwriters should also consider outlawing stock-lending until a rights issue has been completed.

In a discussion paper on its website, the influential fund management group said that, if adopted, the same principles should apply to sub-underwriters. These investors, ranging from long-term owners to hedge funds, agree in advance to take up an allocation of new shares.

Publication of the ABI paper comes as a high-level working group, co-ordinated by the Treasury and the Financial Services Authority considers how to speed up rights issues and make them more efficient.

The ABI argues that it would far prefer to see the introduction of a voluntary arrangement, rather than prescriptive regulation.

The rights issue process, widely seen as cumbersome and in dire need of reform, has been thrown into the spotlight by a spate of recent fundraisings from companies including HBOS and Bradford & Bingley, the mortgage lenders.

Fierce short-selling by hedge funds and other investors have threatened to destabilise the offering by driving the banks’ shares below the rights issue price, making them unattractive to investors.

Morgan Stanley, one of two investment banks to underwrite the HBOS share issue, also attracted criticism for shorting its shares to the apparent detriment of other investors.

The ABI said it was prepared to back a code of best practice governing the behaviour of investors during rights issues and said that investment banks should consider doing the same.

It was crucial that rights should be tradeable so that investors could be compensated for being diluted if they decide not to subscribe, the ABI said.

It also said that investment banks should be “encouraged” to pass on sub-underwriting risk to long-term investors who would be less likely to engage in short-selling.

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