(Bloomberg) — South Korean stocks rose after the country reimposed a blanket ban on short selling, a controversial move regulators said was meant to prevent illegal use of a trading tactic routinely used by hedge funds and other investors around the world.
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The nearly eight-month moratorium will help appease retail investors who have complained about the impact of the shortfall — selling shares borrowed by institutional investors ahead of elections in April, many market watchers said. However, it could limit the participation of foreign funds in the $1.7 trillion stock market and complicate Korea’s bid to earn developed market status in MSCI Inc’s indices.
The Kospi ended the day up 5.7% to cap its biggest gain since March 2020 amid a surge in trading volumes. Foreign investors were the biggest buyers on a net basis, indicating that funds covered short positions. Stocks that saw an increase in short selling recently – including LG Energy Solutions Ltd and Bosco Future M Co – were the biggest contributors to the benchmark’s advance. The smaller COST index rose 7.3%.
Read: Korea eases curbs to affect its developed market Purpose: Street wrap
New short selling positions in the Kospi 200 Index and Kosdaq 150 Index will be prohibited from Monday until the end of June 2024, the Financial Services Authority said on Sunday. This decision will not affect existing positions. Although the pandemic-period bans were effectively lifted for those two metrics in May 2021, the ban remained in place for about 2,000 stocks.
“This policy change is unnecessary at this time in terms of short selling,” said Wongmo Kang, an analyst at Exom Asset Management. “Many see it as a political move aimed at next year’s general election,” he said, adding that the Korean market will be “heavily affected by retail investors.”
South Korea is due to hold general elections for the National Assembly in April and public opinion about short selling is deeply negative in the country. Some ruling party lawmakers urged the government to temporarily halt short-selling of stocks in response to demands from retail investors, who have periodically staged protests against the tactic and sporadic concerted efforts to acquire stocks targeted by short-sellers.
Most short sales in South Korea are conducted by institutional investors. However, it has a small share of the market – 0.6% of Kospi’s market value and 1.6% of Kostak’s, according to exchange data.
Lee Bokyun, governor of the Financial Supervisory Service, denied the suggestion that the ban was politically motivated, saying the suspension was necessary to protect retail investors and improve the short-selling mechanism. “The ban is inevitable to introduce an advanced short selling system,” he was quoted as saying by Yonhap Infomax.
Sunday’s announcement came days after the financial watchdog said it was planning a comprehensive investigation into global investment banks’ short-selling trades in an effort to root out the illegal practice of naked short-selling in South Korea. Earlier in October, the FSS proposed to impose registration penalties on two global banks for engaging in “routine and deliberate” gross short selling.
The so-called barebones type of trading involves shorting stocks without first borrowing.
Read: Korea to fine banks for naked shorts; Local media name HSBC, BNP
Kospi surged earlier this year on a frenzy of buying electric-vehicle battery names and chip stocks related to the artificial intelligence theme. Concerns about geopolitical tensions and higher interest rates have altered the rally in recent months, leading to a technical correction and nearly erasing its gains for the year.
The volume is now up nearly 12% in 2023, compared with a 2.6% advance in the broader MSCI Asia Pacific index. On Monday, trading volume on the Kosby was 70% above its average over the past 10 sessions, according to NH Investments.
The latest ban is “unusual” because authorities ban short selling outright when there is no major external risk, said Hu Jae-hwan, an analyst at Eugene Investment & Securities. South Korea banned short selling during the global financial crisis in 2008, amid the euro-zone debt crisis and the US sovereign default in 2011, and again in 2020 during the start of the pandemic.
While regulators argue that blatant short selling prevents fair price formation and hurts confidence, some observers argue that broad transparency barriers make the market less transparent and therefore less attractive. Some regulators also say that the market in MSCI indices may not improve.
“This will compromise their position and certainly prevent them from achieving a developed market position,” said Gary Dugan, chief investment officer at Dalma Capital Management Ltd. Prices of companies with some short selling,” but the overall market may have less short positions, he said.
A spokeswoman for MSCI said the index provider does not comment on potential future reclassifications. The head of the country’s stock exchange said in an interview earlier this year that South Korea must take the politically important step of fully removing restrictions on stock short selling to ensure its inclusion in a major global index.
“International investors are likely to lose confidence and opportunity in the Korean market,” Exome Asset’s Kang said. “Without the ability for investors to express a perception that markets and individual stocks are ‘mispriced’ upside, stock markets lose long-term credibility on the global stage.”
–With help from Abhishek Vishnoi.
(Updates throughout. An earlier version of this story has been edited to show that the ban was partially lifted in May 2021.)
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