[NEWS ANALYSIS] Short selling ban triggers backlash, market fluctuations

The full ban on short selling has added volatility to Korean stock markets, but experts predict its impacts to be short-lived.

Electronic display boards at Hana Bank in central Seoul show the Korean market on Monday, top, and Tuesday, above, when the market rallied and flopped, respectively, following the introduction of the short selling ban at the beginning of the week. [YONHAP]

Korean stock market has been on a roller coaster ride since Monday's introduction of full ban on short selling, dividing views of the controversial maneuver's actual impact.

The market immediately grew volatile after the ban. The Korea Exchange activated the sidecar curb for two consecutive trading days, prompted by a steep surge on Monday and again by a plummet on the following day.

The restriction may please some retail investors, many of whom have blamed short selling as a primary driver of weakness in Korea's stock market. But experts expect its impact on the market to be short-lived.

After Korea's past three short selling bans, the Kospi has eventually moved in step with the S&P 500. Kim Jong-yeong, an analyst at IBK Securities, says that this period will be no exception.

“Impacts of the short selling restriction will be diluted as time passes,” Kim said. “That would make the movement of interest rates more important at this point, which is one of the main factors driving the current U.S. stock market.”

Higher interest rates tend to make investors more reluctant to bid up stock prices, as the value of future earnings looks less attractive.

On Sunday, Korea’s financial authorities announced a full ban on all stocks, excluding market makers and liquidity providers, through next June. The move was part of the government's efforts to level the playing field for retail investors and to prevent illegal short selling, a practice that was observed in some global investment banks operating in the country.

The announcement was unusual — the previous three bans were followed by global financial risks after the 2008 global financial crisis, the 2011 European debt crisis and the Covid-19 outbreak in 2020. In 2021, regulators partially lifted the ban to allow short selling positions on stocks in the Kospi 200 and Kosdaq 150 indexes.

Some critics have described the ban to be inconsistent with financial regulators' past pledges to improve foreign access to the Korean capital market, including extensions of foreign exchange trading hours.

Earlier this year, the financial authorities said they would consider a complete resumption of short-selling. Such a decision would allow Korean markets greater access to foreign funds, and could potentially help upgrade the country from its current emerging market status on the Morgan Stanley Capital International (MSCI) global index to developed market status.

The upgrade is seen to be essential for fund flows, which contribute to market stability.

Seoul has made multiple attempts to move up the index. The MSCI has turned them down and cited weak market accessibility for foreign investors — which includes restrictions on short selling.

Financial authorities are defending the decision.

Finance Minister Choo Kyung-ho said at a plenary session on Tuesday that he believes the short selling ban to be a good policy for the current moment.

“The government will continue to progress with systematic improvements aimed to be [upgraded] on the MSCI index,” he added, while admitting that short sale is one of the conditions the MSCI considers in determining status.

Past short sale bans have reduced market liquidity and, in turn, aggravated the market rather than stabilizing it, according to a report the Korea Capital Market Institute released in May.

Short selling, and the purchase of stocks for it, creates additional market liquidity.

“It is [more] desirable to design stepwise regulation and to prohibit illegal activity than to call for a market-wide ban on short selling,” the report added.

“Stricter regulations of illegal short selling are necessary because the proportion of retail investors in the Korean market is very high, making them especially vulnerable” to the impacts of the trading tactic, said Lee Jeong-hwan, an associate professor at Hanyang University’s College of Economics and Finance.

Retail investors accounted for 64 percent of the stock market in Korea as of late last year, far higher than the 36.5 percent they accounted for in Japan in the same period and 22 percent in the United States at the end of 2021, according to the respective countries' stock exchanges.

“But the need for stricter regulations and investigations [of illegal short selling], and the restriction of the practice are separate matters that hardly have any logical correlations,” Lee added.

BY JIN MIN-JI [jin.minji@joongang.co.kr]