South Korean stocks soar as regulators reimpose ban on short-selling
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South Korean stocks experienced a significant surge after regulators decided to reintroduce a complete ban on short-selling for a duration of approximately eight months. This move, considered controversial by many, was deemed necessary by authorities to curb the illicit use of a trading tactic commonly employed by hedge funds and other global investors.
The ban is expected to resonate with retail investors who have voiced concerns about the detrimental effects of shorting, which involves selling borrowed shares, especially in the context of the approaching elections in April. However, the prohibition may deter certain foreign investors and impede the upgrade of Korean equities to developed market status by MSCI Inc.
The benchmark Kospi registered a surge of up to 4%, the most significant increase since January 2021, outpacing other major regional gauges in Asia on Monday. Stocks that recently witnessed a rise in short-selling positions, including LG Energy Solution Ltd. and Posco Future M Co., proved to be crucial contributors to the market upswing. The small-cap Kosdaq Index also recorded a surge of up to 5.9%, the highest since June 2020.
The Financial Services Commission of South Korea revealed on Sunday that new short-selling positions for equities in the Kospi 200 Index and Kosdaq 150 Index would be prohibited from Monday until the end of June 2024. Although pandemic-related restrictions on short-selling were lifted for these two indexes in May 2021, the ban remained in effect for around 2,000 stocks.
This decision comes before the general elections for the National Assembly in South Korea, where short-selling has garnered widespread negative sentiment. In response to demands from retail investors, who have organized protests against the tactic, certain ruling party lawmakers urged the government to temporarily halt stock short-selling. It is crucial to note that institutional investors primarily conduct short-selling in South Korea.
Wongmo Kang, an analyst at Exome Asset Management, commented that the reversal of short-selling policy is unwarranted at this time. He believes that many view it as a political maneuver aimed at next year’s general elections. Kang also highlighted the significant influence of retail investors on the Korean market.
The Kospi experienced a surge earlier this year due to frenzied purchases of electric-vehicle battery-related stocks and chip stocks related to the artificial intelligence theme. However, concerns surrounding geopolitical tensions and high interest rates contributed to a recent reversal in the market rally. Consequently, the benchmark entered a technical correction and nearly erased its year-to-date gain.
According to Huh Jae-Hwan, an analyst at Eugene Investment & Securities, the latest ban is considered “unusual” as authorities are implementing a comprehensive prohibition on short-selling during a period without a financial crisis.
The financial regulator attributed the disruption in the market to “massive” naked short-selling by global investment banks. Naked short-selling involves shorting shares without borrowing them first. The regulator aims to enhance fairness for retail investors by implementing improvements and imposing stricter penalties on traders who violate the rules.
While regulators argue that naked short-selling impedes fair price formation and erodes confidence, some observers suggest that broad outright bans make the market less transparent and, consequently, less attractive. Furthermore, these restrictions may hinder the market’s potential upgrade in MSCI indexes.
Dalma Capital Management Ltd.’s Chief Investment Officer, Gary Dugan, remarked that the ban compromises South Korea’s market status and could impede its progression to developed market status. He expects an initial sharp increase in stock prices of companies that have experienced short selling due to the immediate ban. However, Dugan believes that the impact may be limited due to the low levels of short positions in the overall market.
Exome Asset’s Kang expressed concerns that the ban may result in a loss of trust and opportunities for international investors in the Korean market. He emphasized the importance of investors’ ability to express their views on mispriced markets and individual stocks, as it contributes to the long-term credibility of stock markets.
— With assistance from Abhishek Vishnoi
An earlier version of this story has been corrected to reflect that the ban was partially lifted in May 2021.
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