South Korea equities rally: Short-selling ban triggers biggest surge since 2021

South Korean stocks experienced a significant surge in response to regulators’ decision to reinstate a complete ban on short selling, a move that has sparked controversy. Regulators argued that this action was necessary to combat the unlawful utilisation of a trading strategy commonly employed by hedge funds and other investors globally.

This ban is expected to address the concerns of retail investors who have voiced grievances regarding the effects of short selling, which involves institutional investors selling borrowed shares. This move is seen as a measure to satisfy retail investors, particularly considering the upcoming elections in April, according to several market analysts. Nevertheless, it could discourage foreign funds from participating in South Korea’s USD 1.7 trillion equity market. It may challenge Korea’s pursuit of achieving a developed-market status within MSCI indices.

The Kospi experienced a substantial increase of up to 5.6%, marking the most significant surge since January 2021, and as of the time of writing this article, it stands at 2,502. It was noteworthy that overseas investors made substantial net purchases, suggesting that funds were closing out their short positions. Interestingly, stocks that had recently experienced elevated levels of short selling, such as LG Energy Solution Limited and Posco Future M Company, played a significant role in driving the benchmark’s gains. In addition, the smaller-cap Kosdaq Index also witnessed a remarkable increase of up to 6.2%, the most substantial surge since March 2020.

The Financial Services Commission announced on Sunday that new short-selling positions for equities on the Kospi 200 Index and Kosdaq 150 Index will be prohibited from Monday through the end of June 2024. This decision does not affect existing positions. Although pandemic-era restrictions on this practice were lifted for those two indices in May 2021, the ban continued to be in effect for around 2,000 stocks.

South Korea is gearing up for general elections in April, and the public’s perception of short selling remains strongly negative in the country. Some lawmakers from the ruling party have urged the government to temporarily halt stock short-selling in response to demands from retail investors. These retail investors have, at times, protested short-selling and made occasional coordinated efforts to boost the stocks targeted by short sellers.

In South Korea, most of the short selling is carried out by institutional investors. However, it represents only a small fraction of the market, accounting for approximately 0.6% of the Kospi’s market value and 1.6% of the Kosdaq’s, as per exchange data.

The financial regulator attributed the market disruption to “massive” naked short selling by global investment banks. In response, they intend to implement more rigorous penalties for traders who violate the rules, with the goal of establishing a fair and equitable environment for retail investors.

While regulators contend that naked short selling disrupts the fair formation of prices and undermines confidence, some observers argue that comprehensive bans on short selling reduce market transparency, potentially making it less appealing.

Disclaimer: This article is intended solely for educational purposes. The securities mentioned are for illustrative purposes and not indicative of recommendations. It is based on information gathered from various secondary sources and is subject to change. Consult with a financial expert before making investment decisions.