'Politically-motivated' ban on short selling darkens foreign investment prospects

An electronic signboard at Seoul's Hana Bank shows the benchmark KOSPI closing at 2,443.96 points, Nov. 7, down 2.33 percent from the previous day. Yonhap

A sudden ban on short-selling in Korea is fueling dispute that such a measure, widely perceived as politically motivated, will hinder the country’s effort to attract foreign investors in return for wooing Korean retail investors ahead of the general elections in 2024.

Financial Services Commission (FSC) Chairman Kim Joo-hyun said on Nov. 5 that the ban on short selling is necessary to counter market uncertainties and concerns that widespread illegal short-selling practices hinder the formation of fair prices in the market.

However, this contrasts with the previous stance by the regulator that allowing short selling is a "global standard."

What is more of a concern is that the ban, taking effect for the next eight months, may have a shorter-than-expected impact in revitalizing the market after the Financial Services Commission (FSC) announced it on Nov. 5.

The possible scenario suggests the consistency as well as credibility in the government’s capital market regulation will be called into question by both domestic and international investors, according to analysts, Tuesday.

“The ban on short-selling should have been taken cautiously considering it can result in flight of foreign capital and other side effects,” Eugene Investment & Securities analyst Kang Song-chul said.

He noted the ban was welcomed by retail investors but threw foreign investors into a frenzy due to colliding interests of the two groups.

Trading with borrowed shares, short-selling is dominantly practiced by foreign investors due to their credibility and capability in funding, which retail investors here relatively lack.

Under the circumstances, short selling brings profit to investors from falling stock prices. The method was protested by retail investors as they rely on higher stock prices to reap profit.

At the same time, the suspension is raising alarm bells for global hedge funds that regularly deploy the tactics. It also complicates Korea’s efforts to win developed-market status from global index provider Morgan Stanley Capital International (MSCI), according to SK Securities analyst Cho Joon-ki.

“It appears Korea is pushed into a more challenging circumstance to reach its goal concerning MSCI status," he said.

Finance Minister Choo Kyung-ho, meanwhile, said that Korea will try to improve the system to win developed market status from the MSCI.

"Short selling is one of many criteria (for inclusion in the index). We didn't say it would be banned forever. It is only banned until June next year," he said.

However, according to the analysts, it is not certain whether the ban will reinvigorate the stock market and please retail investors.

They pointed out foreigners dumped more than 400 billion won ($306.3 million) worth of shares at the benchmark KOSPI and junior bourse Kosdaq combined, Tuesday, a turnaround from a net purchase of 1.2 trillion won a day earlier.

The net purchase reflected short covering or buying back of the borrowed shares in order to return them to lenders.

“It appears the effect of the ban on short-selling was mostly over as of Monday,” IBK Securities researcher Chung Yong-taek said.

He referred to KOSPI surging 5.66 percent – the highest rate in almost four years – to close at 2,502.37 points, Monday, and then tumbling 2.33 percent, Tuesday, to settle at 2,443.96 points.

Kosdaq retreated 1.8 percent to close at 824.37, Tuesday, after it went up 7.34 percent to 839.45 a day earlier.

In particular, a sidecar curb was triggered for two straight days for different reasons. It was activated on Monday not because the prices went up too fast, but because they went down too fast.