[Editorial] Ban on short selling

Regulators reimposed a ban on short selling on Monday, which resulted in a big jump in stocks -- a sign that the restrictions were taken as a positive development among investors, at least in the short term.

The benchmark Kospi ended up 5.66 percent, the biggest increase since March 25, 2020, as the ban on short selling came into effect Monday, but the index dropped 2.33 percent Tuesday on heavy selling by institutions and foreigners. The ban is scheduled to last until June.

The question is whether the ban will dispel concerns about market volatility related to short selling or, as some critics argue, undermine the appeal of the country’s capital markets to foreign investors.

Financial regulators seem to believe that the restriction is necessary at this point. In a meeting with reporters Monday, Lee Bok-hyun, head of the Financial Supervisory Service, stressed the need to temporarily ban short selling on the stock market, which is aimed at “restoring a level playing field” for retail investors.

“It was an inevitable choice in order to introduce an advanced short selling system,” the FSS chief said. “It is not a road where there is lots of broken glass, but one where all glass is completely shattered.”

The country’s financial regulators confirmed that some 100 listed stocks have been subject to illegal short selling, or what is called “naked short selling” -- the practice of short selling stocks without first making borrowing arrangements.

Critics have long claimed that retail investors were at a disadvantage compared to institutional investors when it comes to the practice of short selling due to the gap in access to market information as well as the unfair application of related regulations.

In particular, the ban was prompted by the regulators’ plan to impose fines on two Hong Kong-based investment banks after their naked short selling activities were revealed.

Given that the country had lifted restrictions on short selling in May 2021 to help elevate the global status of the local capital market, the reimposition of the ban here is now generating myriad interpretations.

As the FSS announced, the official reason for the ban is to level the playing field for investors and come up with an advanced short selling system on par with other foreign markets. Short selling itself is generally allowed across the world, as it has a positive function in stabilizing markets. Only naked short selling activities are regulated to ensure market stability.

That is why the regulators said they need about eight months to draw up a new short selling system in a bid to close loopholes, one of which is the current onerous collateral standards and stock resale requirements imposed on retail investors.

Aside from naked short selling, the uneven playing field in regulations forced many retail investors to give up on legitimate short selling strategies. As a result, retail investors make up only 2 percent of the local short selling market, while institutional and foreign investors account for 98 percent.

One controversial issue involves the timing of the ban, as the eight-month duration encompasses the general election in April next year. Political pundits have floated the view that President Yoon Suk Yeol and the ruling People Power Party are trying to secure votes from retail investors after suffering a crushing defeat in the Oct. 11 by-election for the head of Seoul’s Gangseo-gu.

Political considerations, however, cannot resolve the problem with the short selling ban.

Critics say the eight-month ban is excessive, calling for far stricter punishment for financial fraud and illegal activities as a fundamental solution to prevent naked short selling. Financial authorities should bear in mind that South Korea is the only member of the Organization for Economic Cooperation and Development that bans short selling.