Fix short selling’s systemic loopholes first

South Korea is putting the lid back on short sales in the Korean stock market through June of next year. The decision from the government and the People Power Party (PPP) came amid mounting demands from retail investors since two Hong Kong-based global investment banks were accused of engaging in outlawed naked short selling.

The governing party has insisted on banning short selling until authorities can come up with measures to correct the “titling playing field” in the local bourse. Although partly legitimate, their intentions cannot be fully innocent. PPP lawmakers revealed in text messages that their next move (to earn votes) after proposing to incorporate Gimpo City into Seoul would be a ban on short sales. The move is suspected to have an eye on votes in the parliamentary elections in April next year rather than on restoring fairness and confidence in the stock market.

The past Moon Jae-in administration twice extended bans on short selling ahead of Seoul’s and Busan’s 2021 mayoral by-elections to court more votes from individual investors. Bringing back a full cap ahead of the upcoming legislative election — despite a lack of major shocks like the Covid-19 pandemic or the global financial crisis — could cost the market its credibility.

Short selling is the investment practice of pawning off borrowed shares in order to buy them back at a lower price, capitalizing on the price difference. Naked short selling unbacked by borrowed assets is illegal in Korea. Although naked short selling by foreign capital can cause confusion in the market, the practice itself has the positive function of containing bubbles around overrated stocks and manipulating forces. Financial authorities have allowed the short selling of large-cap stocks after a 14-month ban since March 2020 to restore market mechanisms.

Korea should be mulling the full liberalization of short sales, which are currently limited to top Kospi 200 and Kosdaq 150 stocks, to induce more foreign capital and elevate Korea’s financial status to the developed market category under the Morgan Stanley Capital Index.

If devising protective measures from illegal activities is the real motive behind this decision, authorities must come up with those measures fast and keep the ban period as shortly as possible.