South Korea lifted its longest short-selling ban in history on Monday. The ban, which restricted short selling on the Korea Exchange, was put in place after a series of violations involving several global investment banks.
Short-selling will now be allowed for all 2,700 listed stocks. In the past, it was only permitted for 350 stocks on the benchmark Kospi and small-cap Kosdaq. The recent restrictions aimed to make the market more stable and accessible to investors.
Penalties for illegal short-selling practices have been increased significantly. Naked short selling, which involves shorting stocks without borrowing them, is still illegal. Retail investors, who make up more than 50% of the market trading volume, see short selling as something that drives down stock prices.
This makes it a politically sensitive issue. KB Securities’ Managing Director Peter Kim said, “Retail investors are a substantial force in our market, making this a key political issue for the government.”
Global investment banks, such as JPMorgan and Morgan Stanley, recently faced penalties for breaking short-selling rules. However, the return of short selling is expected to boost the South Korean market.
Analysts from Macquarie said, “Value is set to outperform growth, and we believe that the resumption of short-selling will likely have a neutral to positive impact on the broad market.”
Goldman Sachs also expects more trading activity from foreign investors, who account for around 70% of total short-selling activities. The investment bank stated, “Once resumed, short-selling activities should improve market efficiency and price discovery, presenting potential alpha opportunities.”
As South Korea allows short selling again, market participants are hopeful about the positive effects on liquidity, transparency, and investor participation. Once the short-selling ban is lifted, South Korea may see a wave of convertible bond issuance.
This is thanks to the likely return of hedge funds, which are major buyers of hybrid debt. A senior banker at Goldman Sachs Group Inc. and money managers at Lombard Odier Investment Managers expect a jump in convertible issuance.
End of short-selling restrictions
It dried up after Korea’s shorting ban in late 2023. The drop was particularly sharp in dollar convertibles, popular among global arbitrage investors who typically buy the debt while shorting the underlying stock.
Arnaud Gernath, chief investment officer of convertible bonds at Lombard Odier Investment Managers, said, “Lifting the short-sale ban will be a game changer for the convertible bond primary market. The pipeline is still developing, and we expect new and former convertible bond issuers to enter the market.”
A revival in convertible bonds would offer companies a cheaper funding alternative, as the notes tend to have lower coupon rates than traditional debt. For investors, the draw is an option to swap the securities for equity if certain conditions are met.
The removal of the short-sale ban is also expected to normalize pricing in the broader financial market, which is good for companies seeking funding. Selling of borrowed shares will be allowed for all of the roughly 2,800 listed companies, a first since the pandemic-era ban in March 2020. New issues are expected to include notes from investment-grade companies seeking lower-cost financing and high-yield issuers previously shut out of the bond market.
Christian Lhert, head of Asia-Pacific equity-linked deals at Goldman Sachs, said, “There was a healthy level of activity before the short-sell ban, and we expect to see that trend return similarly.”
Short-selling will be allowed for all shares on Seoul’s stock market starting Monday, marking the end of a five-year ban, the longest such period in the country’s stock market history. Analysts suggest that the most likely affected industries include defense and shipbuilding, which may face considerable short-selling pressure. The decision to lift the ban is seen as a step towards making the South Korean market more international, with the potential to include its shares in global indexes.
However, domestic investors have expressed concerns about the potential for increased market volatility in the near term. The ban on short-selling was initially imposed to stabilize the market and protect it from speculative trading after global financial instability. Its removal is expected to bring renewed interest from foreign investors but also presents a challenge to South Korean companies that could become targets for short-sellers.
While the move aligns with global financial practices, monitoring its impact on specific sectors, especially those seen as vulnerable, will be important. Defense and shipbuilding stocks are expected to face notable challenges, and the broader implications for the South Korean market remain to be seen. Authorities have indicated their readiness to impose penalties on any attempts to manipulate the market through short-selling, aiming to maintain investor confidence during this transition.
The lifting of the ban marks a significant shift in South Korea’s financial policy, advancing efforts to integrate the country’s stock market into the global financial system. However, the true impact on various sectors will unfold in the coming weeks and months.
Image Credits: Photo by Daniel Bernard on Unsplash
