South Korean stocks soared after the country reimposed a full ban on short-selling, a controversial move that regulators said was needed to stop the illegal use of a trading tactic deployed regularly by hedge funds and other investors around the world.
The nearly eight-month ban might help appease retail investors who have complained about the impact of shorting — the selling of borrowed shares by institutional investors — ahead of general elections for the National Assembly in April next year, several market watchers said.
However, it could deter participation by foreign funds in the US$1.7 trillion equity market and complicate South Korea’s bid to seek a developed-market status in MSCI Inc’s indices, they added.
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The KOSPI ended the day up 5.7 percent to cap its biggest gain since March 2020 amid a surge in trading volumes. Overseas investors were big buyers on a net basis, indicating that funds were covering short positions. The small-cap KOSDAQ jumped 7.3 percent.
The Financial Services Commission said on Sunday that new short-selling positions will be prohibited for equities on the KOSPI 200 Index and KOSDAQ 150 Index from yesterday through the end of June next year. The decision does not impact existing positions. While pandemic-era curbs on the practice had been lifted for those two gauges in May 2021, the ban had remained in place for about 2,000 stocks.
“This policy reversal with respect to short selling is unwarranted at the current time,” Exome Asset Management LLC analyst Wongmo Kang said. “Many people view it as a political move aimed at next year’s general election,” he said, adding that the South Korean market tends to be “heavily influenced by retail investors.”
Most short-selling in South Korea is conducted by institutional investors. However, it accounts for a tiny portion of the market — about 0.6 percent of the KOSPI’s market value and 1.6 percent of the KOSDAQ’s, according to exchange data.
South Korean Financial Supervisory Service Governor Lee Bok-hyun dismissed the view that the ban was politically motivated, adding that the suspension was necessary to protect retail investors and improve the short-selling mechanism. The ban was “inevitable to introduce an advanced short-selling system,” he was cited as saying by Yonhap Infomax.
Sunday’s announcement comes just days after the financial watchdog said it plans a comprehensive probe into short-selling trades by global investment banks, with a view to root out the practice of naked short-selling, which is illegal in South Korea. Earlier last month, the FSS proposed the imposition of record fines on two global banks for “routinely and intentionally” engaging in naked short-selling.
The so-called naked variety of the trade involves shorting shares without borrowing them first.
The KOSPI is up almost 12 percent this year versus a 2.6 percent advance in the broader MSCI Asia-Pacific Index. The gauge’s trading volume yesterday was 70 percent higher than the average over the past 10 sessions, according to NH Investment and Securities Co.
A spokeswoman for MSCI said the index provider does not comment on potential future reclassifications. South Korea needs to take the politically sensitive step of fully lifting curbs on stock short selling to ensure inclusion in a key global index, the head of the country’s securities exchange said in an interview earlier this year.
“There is a possibility that international investors may lose trust and opportunity in the Korean market,” Kang said. “Without the ability for investors to express a view that markets and individual stocks are ‘mispriced’ to the upside, stock markets lose long-term credibility on the world stage.”
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