In a controversial move, South Korea has enacted a blanket prohibition on short-selling of stocks until June 2024. The ban announced by the Financial Services Commission (FSC) applies to all equities on the benchmark Kospi 200 and small-cap Kosdaq 150 indexes starting Monday. Regulators say the drastic step aims to stabilize markets and protect retail investors amid allegations of manipulation by global banks. However, critics argue the ban could distort prices and hurt Korea’s capital markets over the long run.

Short-selling involves borrowing shares to immediately sell them, betting on a subsequent price decline. The practice was partially allowed again in 2021 after a pandemic ban. But regulators now believe rampant naked short-selling and other abuses require a comprehensive suspension to restore fairness.

“We’ve discovered massive illegal naked short-selling by global investment banks and circumstances of additional illegal activities,” said FSC Chairman Kim Joo-hyun. “It’s a grave situation where illegal short-selling undermines fair price formation and hurts market confidence.”

Authorities Vow to Overhaul Short-Selling Rules

Officials stated that the nearly 18-month ban will provide time to overhaul short-selling regulations and systems. There are plans to align requirements between institutional and retail investors to create a more level playing field. Stronger punishments for naked short-selling and other violations are also under consideration.

A special investigation team will probe short-selling transactions by around 10 global banks that allegedly account for most of the activity in Korea. Local media have named HSBC and BNP Paribas among institutions being scrutinized. Violators could face heavy fines if found guilty of market manipulation.

The short-selling prohibition comes ahead of key National Assembly elections in April 2023. Some ruling party lawmakers lobbied for the move in response to vocal retail investor protests. Many individuals believe short-selling grants unfair advantages to large foreign funds and institutions.

Critics argue the ban could create distortions and bubbles in Korean equities. By removing the brakes on absurd valuations, it risks undermining Korea’s bid to upgrade from emerging to developed market status.

Understanding Short-Selling Controversy in Korea

Short-selling represents a tiny fraction of South Korea’s $1.7 trillion stock market. Exchange data shows it accounting for only 0.6% of the Kospi and 1.6% of the Kosdaq. But short-selling has remained deeply controversial in Korea’s volatile, sentiment-driven equity market.

Many retail investors accuse short-sellers of driving sharp declines and increasing volatility. However, defenders argue the practice enhances liquidity and enables efficient price discovery by allowing bearish positions.

Regulators permitted short-selling on the Kospi and Kosdaq in May 2021 after suspending it during the pandemic downturn. But everyday investors staged protests demanding authorities ban it again to curb the perceived excesses of foreign traders.

With elections approaching, the administration of President Yoon Suk Yeol faces populist pressure to take action against short-selling. The move aligns with Yoon’s reform agenda, including preventing market monopolies.

But analysts say abruptly suspending short-selling could undermine Korea’s reputation among global investors. They argue regulators should have first enhanced oversight and transparency around the practice.

Korea’s Financial Markets Eye an Uneasy Recovery

The blanket short-selling ban comes as Korean equities attempt to rebound from a punishing 2022. Korea’s economy faces myriad headwinds from slowing exports, rising rates and currency weakness.

After plunging in October, the benchmark Kospi managed to stabilize in November. But it remains down over 10% from summer highs. The tech-heavy Kosdaq also found a floor after hitting a 2022 low in October. However, it is still off nearly 20% from its peak last July.

With recession concerns mounting, Korean stocks face a challenging fundamental backdrop in 2023. Critics warn the short-selling prohibition could create distortions that exacerbate volatility down the road.

However, regulators are under pressure to be seen as protecting retail investors who account for over 70% of daily trading. With elections ahead, the ban enables the government to show decisive action against practices unpopular with the public.

The key question is whether regulators take advantage of the 18-month suspension window to implement structural improvements. Rather than an outright ban, Korea may need a transparent short-selling framework ensuring accountability and fairness for all market participants.

Striking the right balance remains a complex challenge. But enhancing stability and trust in Korean capital markets is vital for the nation’s ambitions as a financial hub. As global uncertainty persists, regulators must avoid reactive policies that inadvertently harm the ecosystem.

With elections fast approaching, authorities are taking a bold but controversial gamble on an outright short-selling ban. Time will tell whether this drastic move pays long-term dividends or distorts Korea’s capital markets further.