Should short selling ban continue for market stability?

18-Jun-2020 Intellasia | KoreaTimes | 6:02 AM Print This Post

About three months have passed since the financial authorities put a six-month temporary ban on short selling on the nation’s bourses March 16. And some observers are wondering whether the ban should be extended to further stabilise the market.

Short selling is a stock investment strategy that investors use to profit when they expect a certain company’s share price to fall. How short selling works is simple: an investor borrows a security and sells the stock on the market, planning to buy it back when the price goes down. Then the short seller returns the stock back to the lender, and the difference in the stock price is the profit.

As short selling can sometimes accelerate a downturn in the market when it’s already volatile, the financial authorities prohibited it on the Korea Exchange (KRX) for six months starting March 16, when the country’s stock markets started to tumble amid the COVID-19 pandemic. Short selling was exceptionally allowed for “market makers” that provided liquidity to the market.

Three months from the end of the short selling ban due September 15, Financial Services Commission (FSC) Chair Eun Sung-soo said during a press conference June 11 that the commission will thoroughly review the effects and consider possible improvements to rules governing short-selling.

“About three months have passed since the ban, and fortunately stock prices have risen. However, we need a strict analysis on whether the market’s rise is attributed to the ban or other factors. There are countries which also saw similar rebounds in their stock markets, with some of them banning short selling, while others didn’t,” Eun said during the press conference.

The FSC chief said he’d thoroughly monitor the market until September.

“Even if the ban is lifted then, the commission will consider possible improvements, and will also consider a possible extension of the ban, if necessary,” he said.

Pros and cons

Market watchers mostly agree that the ban on short selling has had a positive effect on the stock market’s quick recovery. As short selling tends to allow excessive selling of shares that are falling, the ban functions as a psychological buttress for individual retail investors to join the turbulent market.

Since the introduction of the ban, individual investors net purchased stocks worth 14.68 trillion won ($1.21 billion), while foreigners net sold 14.28 trillion won. The KOSPI has also risen 50.6 percent, as of June 10, from its lowest point on March 19, when the index plummeted to 1,457.64 amid the spread of COVID-19 nationwide. The secondary KOSDAQ market has risen by 77.1 percent from its lowest point, also in March.

A recent report by Shinhan Financial Investment pointed out that the KOSPI index rose by more than 9 percent thanks to the ban on short selling.

Some even argue that short selling should be banned completely, as betting on a market downturn reduces investment sentiment and suppresses rises in share prices.

Short selling on Korea’s stock markets is mostly done by institutional and foreign investors. Last year, 99.16 percent of the short selling was by foreigners (59.09 percent) and institutional investors (40.07 percent). This is due to the complicated process for retail investors to borrow stocks and their lack of awareness of the process. In Japan, about 18 percent of retail investors use short selling, as the process is much simpler than in Korea.

Hwang Sei-woon, a researcher at Korea Capital Market Institute, also pointed out the need for reasonable improvements to the nation’s short selling.

“Some individual investors argue that short selling should be prohibited, yet its abolition must be approached cautiously. Rather than a complete ban, making improvements to the short selling system in a way that enhances retail individuals’ access is a more reasonable policy direction,” the researcher told The Korea Times.

The researcher also added that if the ban on short selling continues, overheating in the stock market could intensify. He suggested a gradual reintroduction, starting with large-cap companies that exceed 30 trillion won in market capitalisation, while protecting small and medium-sized companies from short selling “attacks.”

Hwang’s suggestion is similar to Hong Kong’s short selling rule, which allows short selling of stocks that meet certain requirements. Earlier this year, the Financial Supervisory Service (FSS) suggested to the FSC that this system could be introduced in Korea.

Another market expert said short selling has the positive function of removing bubbles in overvalued stocks.

“Short selling could be banned when the market is panicked, yet I think it should allowed when the market has found its stability,” said Kim Yong-koo, a researcher at Hana Financial Investment.

Given such benefits, some argue that short-selling should be allowed, except in cases of extreme market volatility. Six European countries ? Italy, France, Greece, Belgium, Spain and Austria ? scrapped their short selling bans in mid-May, two months after they put them into effect.


Category: Korea

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