SEOUL, Feb. 1 (Korea Bizwire) — Amid fanfare over a stock bull run, South Korea’s financial regulator is in a tight spot over whether to allow short selling as scheduled in March as more retail investors have demanded an outright ban on the trading tactics for a level playing field with institutional investors.
With the country’s stock market on a bull run, the Financial Services Commission (FSC) is reviewing whether to extend a temporary ban on short selling, set to end on March 15.
The FSC imposed a six-month ban on short selling in March last year in a bid to ease market rout caused by the COVID-19 pandemic. It has extended the move by another six months until March.
Short selling is a trading technique in which investors sell stocks they borrowed in expectations that share prices will fall. When the prices decline, they can make profits by buying back the stocks at lower prices.
It is not the first time that the Korean regulator placed a temporary ban on short selling in time of market panic. But the issue has recently been in the spotlight with the clout of retail investors noticeably growing in the local stock market.
Retail investors, estimated at around 7 million here, have emerged as a new horde of strong buyers of local stocks since 2020 in a market which has largely been swayed by foreign and institutional investors.
The country’s key stock price index jumped about 30 percent last year on the back of individual investors’ buying spree and closed above the 3,000-point mark for the first time on Jan. 7.
Short selling, a globally used risk-hedging strategy, plays a positive role in providing liquidity to markets and preventing price bubble creation. But it can also amplify market volatility and be exploited as a means of price manipulation.
Korean retail investors have long criticized short selling for working only favorably for institutional and foreign investors that have greater access to capital and information.
Angry investors even call it an “axis of evil” that creates a playing field tilted against them.
To use short selling, mom-and-pop investors are allowed to borrow shares for a shorter period of time and with a relatively higher commission fee compared to institutional and foreign investors. Only a few securities firms lend stocks to retail investors.
Short selling by smaller investors accounted for a mere 1.1 percent of the total of such transactions worth 103.5 trillion won (US$92.6 billion) in 2019, according to the bourse operator Korea Exchange. The portion of foreigners was 62.8 percent.
An online petition demanding an outright ban on short selling, posted on the presidential office’s website, has garnered more than 200,000 signatures.
“Under the current ban on short selling, there is not a single problem with the operation of the stock market,” an anonymous petitioner wrote.
“If authorities resume short selling, the government and the ruling party will have to face the strongest-ever headwinds and people’s judgment.”
Apparently mindful of voter sentiment in the run-up to by-elections in April and the presidential election next year, the ruling Democratic Party is pushing for delaying the resumption of short selling until June.
The International Monetary Fund (IMF) suggested last week that South Korea remove a ban on short selling as the financial market has stabilized from the fallout of the pandemic.
“This will improve the functioning of markets and also help ensure investors are more sensitive to risks,” Andreas Bauer, IMF Korea Mission Chief, said at a virtual press briefing Thursday.
Bauer said an outright ban on short selling is a “very blunt instrument” to address concerns about the issue of retail investor protection and would incur considerable costs in terms of market efficiency.
Experts said the country should reinstate short selling to help its stock market win Morgan Stanley Capital International’s (MSCI) developed market status down the road.
The FSC initially said it will lift a ban on short selling as scheduled but backpedaled on its stance, apparently amid pressure from retail investors and politicians, saying that nothing has been decided.
“As retail investors have become major market players since 2020, authorities would be able to resume short selling only after creating a level playing field to some degree. If not, a backlash from them will be anticipated,” said Yoo Keun-tak, an analyst at Kiwoom Securities Co.
The regulator is weighing the timing of the resumption of short selling, while preparing to improve the system to operate it. Expectations are growing that it may extend the ban until June in a bid to draw up protective measures for retail investors.
Starting on April 6, a revision to the Capital Market Act will take effect. The law is designed to strengthen punishment on those who engage in illegal naked short selling, or the sale of shares without borrowing the stocks.
The FSC also plans to improve the stock loan system to enable individual investors to better access stock borrowing for short selling.
As of 2019, retail investors borrowed a combined 23 billion won worth of stocks for short selling, far smaller than 67 trillion won worth of borrowed shares for foreign and institutional investors, according to Korea Securities Finance Corp.
Analysts said the future movement of share prices is expected to greatly affect the regulator’s decision over short selling.
The country’s stock market showed high volatility in recent sessions. On Jan. 25, the benchmark stock index soared above 3,200 for the first time. But four days later, it plunged by 3 percent below the 3,000-point mark on foreigners’ selling spree.