Korea bans short selling; battery stocks lead market rally

South Korea has temporarily suspended short selling partly to prevent illegal, naked short selling, a decision buoying stocks heavily targeted by short sellers but boding ill for the upgrading of Korea’s status as a developed market by the global index provider MSCI.

The Financial Services Commission (FSC), Korea’s top financial regulator, on Sunday announced a decision to ban short selling in the country from Monday to at least June next year after an emergency meeting on the same day.

“We have concluded that the growing market volatility and prevalent illegal short selling will make the market unstable and prevent fair value creation,” FSC Chairman Kim Joo-hyun said during a news briefing on Sunday.

“We will actively seek to come up with measures to fundamentally ease the tilted playing field” between institutional and retail investors, Kim added.

The decision comes after retail investors have been calling for a complete ban on short selling, often blamed for massive losses to mom-and-pop investors with limited shorting options.

The financial watchdog last week warned of a wider crackdown on illegal short selling by major foreign investment banks to ease concerns over the impact of such practices on local stocks after imposing fines on foreign IBs for illegal short-selling practices.

KOREAN STOCKS WELCOME THE BAN

Welcoming the decision, electric vehicle battery-related and information technology stocks, suspected to have been dragged down by hefty short selling so far this year, galloped on Monday.

Battery materials producers EcoPro Co. and EcoPro BM Co. surged by a daily limit of 30% on Monday to close at 828,000 won ($638.15) and 299,000 won, respectively.

Other battery materials stocks POSCO Holdings Inc. and POSCO Future M Co., which plunged in recent months, also zoomed 19.2% to 522,000 won and 30% to 349,500 won, respectively. 

Korea's top battery maker LG Energy Solution Ltd. rallied 22.8% to 493,500 won.  

The country's internet giant Kakao Corp. jumped 8.2% to 44,700 won. 

Thanks to the stellar performance of the blue-chip stocks, Korea’s benchmark Kospi index recovered above 2,500 on Monday after gaining 5.7% on foreign and institutional net buying. The junior Kosdaq climbed 7.3% to 839.45.

Kakao was one of the victims of one foreign IB’s naked short-selling practice, according to the Financial Supervisor Service (FSS) investigation result in mid-October. The battery materials stocks were also heavily targeted by such illegal trading by foreign IBs.

Short selling is a legitimate stock trading practice, which allows traders to borrow shares to trade stocks and to buy back them later at a lower price to pocket the difference.

But naked short selling, a practice that shorts stocks without making borrowing arrangements first, is not allowed in Korea.

The number of such cases increased from 14 in 2021 to 28 in 2022 and 27 in the January-August period of this year, according to the FSS.

SHORT-SELLING BANs UNALIGNED WITH GLOBAL STANDARDS

But Korea’s frequent short-selling bans are also a cause for concern, warned some market analysts, saying they aren't in line with global standards.  

This is the fourth time Asia’s fourth-largest economy has suspended short selling, following the ban in 2008 in the aftermath of the global financial meltdown, as well as 2011 and 2020 to cushion the financial shocks from the liquidity crunch in Europe and the COVID-19 pandemic, respectively.

But this is the first time the financial authorities have completely banned short selling without any imminent risk from a worldwide financial crisis, raising concerns that the ban would weaken the reliability of the Korean capital market among offshore investors.

The country in May 2021 partially lifted a 14-month ban as a COVID-19-related measure to allow short selling of large stocks listed on the Kospi 200 and the Kosdaq 150 indexes despite opposition from retail investors calling for a complete and permanent ban.

The partial resumption came after foreign and institutional investors vocally opposed the ban, saying it damaged investment sentiment and was not in line with global standards.

The latest ban will also likely delay MSCI’s upgrade of Korea’s status to a developed market from its emerging market status, which has been maintained since 1992.

MSCI Inc., or Morgan Stanley Capital International, has cited Korea’s poor market accessibility as one reason it has refused to grant the country developed market status while citing Korea’s short-selling ban on small stocks as a key hurdle.

During the latest ban, which could be extended beyond June, the Korean government and financial authorities said they will improve the country’s short-selling trading system to allow retail investors to have similar short-selling rights as those of institutional investors.

But that would not be possible, considering that institutional investors generally have higher credit ratings than retail investors.

Korea’s ruling People Power Party (PPP), which has been actively suggesting a short-selling ban, has also called for the complete digitalization of short-selling trading, the creation of a real-time monitoring system and the strict and prompt imposition of fines on illegal short-selling practices.

Such changes, however, would require a complete overhaul of the trading system at foreign banks’ headquarters.

It also remains to be seen whether the short-selling ban will continue to be a boon to Korean stocks considering that previous short-selling suspension cases have had limited positive impact on the overall stock market. 

Market fundamentals also matter more than short covering in boosting stocks, said market analysts. 

(Updated with the closing prices of individual stocks and the Kospi and Kosdaq indexes) 

Write to Han-Gyeol Seon at always@hankyung.com

Sookyung Seo edited this article.