South Korea Bans stock short-selling

Experts, media see potential negative impact of 'populism' ahead of April election

· Short-selling is selling a stock borrowed from a broker for a fee on the assumption its price will fall. The borrower sells the shares before they decline and then buys them back at the lower price to return them to the lender, pocketing the difference.

· Overall, the index has increased 5.4% in the three weeks since the ban as of Friday's close.

· Bloomberg News reported that investor risk-hedging is causing futures for some South Korean companies to be discounted to their spot prices by up to 6%.

· The number of retail investors in South Korea reached 14.2 million in December, up from 13.7 million a year ago, accounting for 27.5% of the country's 51.6 million people. They owned a combined 56.1 billion shares in 2,500 stocks, half of the total shares in the market, according to data from Korea Securities Depository.

· South Korea is aiming to join MSCI's developed markets indexes, which ask members to adopt short-selling. Only three countries or regions in Asia -- Japan, Hong Kong and Singapore -- are included in the 23-member indexes.

[ABS News Service/27.11.2023]

South Korea's ban this month on short-selling of stocks has been welcomed by the country's vocal army of retail investors who claim the practice favors institutional counterparts but criticized by analysts as a government ploy to win their support in national legislative elections next year.

The bombshell from market regulator the Financial Services Commission (FSC) came on Nov. 5, at an unscheduled Sunday briefing when it was announced that there would be a prohibition on short-selling in Seoul stock markets -- except for market makers and liquidity providers -- from the next day until the end of June 2024 -- almost eight months.

Short-selling is selling a stock borrowed from a broker for a fee on the assumption its price will fall. The borrower sells the shares before they decline and then buys them back at the lower price to return them to the lender, pocketing the difference. Though risky for the borrower, the practice is seen as helping investors target overvalued stocks and maintaining broader market health.

But South Korea's retail investors, who have complained -- sometimes vociferously -- that institutional short selling suppresses share prices, have cheered the move.

"So many retail investors lost money in the stock market, leading to divorces and even suicides," said Jung Eui-jung, head of the Korea Stockholders Alliance (KSA). "This is a social problem. I know short-selling has some good functions in theory, but only institutional investors benefit from it in practice. It's like plunder."

The abrupt action by FSC sent shock waves through the benchmark Korea Composite Stock Price Index (KOSPI) stock market, which jumped 5.7% on Nov. 6 -- the first trading day after the ban's imposition. It was the biggest daily increase in three-and-half years, before falling 2.3% the next day.

Overall, the index has increased 5.4% in the three weeks since the ban as of Friday's close. The smaller -- and often highly volatile -- Kosdaq bourse rose 4.2%. The move comes as the KOSPI has risen 12.2% so far in 2023, while the Kosdaq has jumped 21.4%.

Analysts, however, caution that the prohibition may undermine markets in the long term by increasing volatility through removing an opportunity to adjust overvalued stocks. Bloomberg News reported that investor risk-hedging is causing futures for some South Korean companies to be discounted to their spot prices by up to 6%.

"As much research on short selling shows, a short-selling ban can cause high price volatility and inefficiency," Kang Jae-hyun, an analyst at SK Securities, said in a note on Nov. 7. "It looks like it's already doing so."

It's not the first time authorities have imposed a short-selling ban. They last did so in March 2020 as the market fell sharply amid the initial stage of the COVID-19 pandemic.

The FSC said that this time the suspension was to ensure "fair play" between institutional and retail investors, despite what is seen as the absence of any urgent market need.

Local media suspect authorities yielded to pressure by President Yoon Suk Yeol's governing People Power Party as retail investors are seen as a powerful electoral bloc. Voting for the National Assembly -- South Korea's legislature -- is set for April next year.

"To ban short-selling ahead of elections may increase the suspicion that it's political populism to buy votes," the mass-circulation Hankook Ilbo newspaper said in an editorial on Nov. 8. "It's an idea which may come from underdeveloped countries."

The number of retail investors in South Korea reached 14.2 million in December, up from 13.7 million a year ago, accounting for 27.5% of the country's 51.6 million people. They owned a combined 56.1 billion shares in 2,500 stocks, half of the total shares in the market, according to data from Korea Securities Depository.

South Korea has a vibrant protest culture and retail investors are no exception, often demonstrating against the FSC. The KSA, a group of 58,000 retail investors, hired a large bus a few years ago and painted a slogan on it reading, "I hate short-selling."

Yoon has publicly expressed sympathy with them.

"We will ban short-selling until we have substantial solutions," Yoon said in a meeting with his cabinet on Nov. 14, arguing the practice can make retail investors inexplicably lose money.

The remarks went over well, with many retail investors leaving heart emojis on a YouTube clip of the speech.

Authorities have suggested that they will make the stock borrowing period equal for both institutional and retail investors at a period of three months when the short-selling ban is lifted, with the condition of possibly extending the period.

The ban also comes at a sensitive time as South Korea is aiming to join MSCI's developed markets indexes, which ask members to adopt short-selling. Only three countries or regions in Asia -- Japan, Hong Kong and Singapore -- are included in the 23-member indexes.