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Korea's short-selling ban to have long-term consequences
03 September 2011
Korea’s temporary ban on short-selling will set back the development of a domestic hedge fund industry, reports Luke Clancy
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South Korea
short-selling ban
FSC
hedge funds
KOSPI
The August stock market correction may have more long-term effects for Korea than any other country in the region. The South Korean stock market declined for six consecutive days, losing nearly 7.5% of its value over August 8 and 9 alone – but while the market will surely rebound the reaction of the regulator will take longer to overcome.
The (FSC) rapidly introduced a comprehensive, albeit temporary, short-selling ban. Whether it has a short-term stabilising effect on the market is debatable; its long-term effect on Korea’s status as a financial centre is negative.
The scale of the market fall made the move understandable. The KOSPI, having stood at 2172 on August 1, dipped below 1700 for the first time since July 2010. But, while the Korean market was hit worse than most, the stock market event was a global.
It was the result of a loss of confidence in the global economic recovery and the events of European debt contagion and US sovereign downgrade. Although Korea’s export-led economy is sensitive to global growth there was no evidence to suggest it was being targeted.
Foreigners and institutions
Nonetheless, the FSC said short-sellers, “mostly foreigners and institutions”, were responsible for spreading market anxiety. It imposed a temporary ban on the short-selling of all listed stocks in the Korea Exchange and Kosdaq markets for three months – from August 10 to November 9. It had already prohibited the shorting of financial stocks.
The FSC implemented the ban following a suggestion from the Korea Exchange. The FSC independently took the decision to proceed, without the influence of any other government bodies. FSC spokesman Ernst Lee says the intention of last month’s ban was twofold: firstly, to prevent any excessively speculative transactions and, secondly, to “give a psychological comfort to the market.”
The penalty for contravening the ban is a KRW50m fine and the FSC says it can also impose “other sanctions” on offending companies. It would not be the first time the Korean authorities took punitive action against foreign short-sellers. In February, Deutsche Bank's Korean securities and exchange-trading operations were slapped with a six-month ban for selling shares in the last minutes of trading with the purpose of making gains from “speculative” derivatives positions built in advance.
The global market turmoil also meant that the Bank of Korea was forced to delay plans to hike interest rates to combat surging inflation in the country, compounding pressure on the already volatile local market.
Market reaction
In the weeks after the ban was introduced, the short interest for the Korea Composite Stock Price Index (KOSPI) fell from 0.52% of market cap on August 9 to as low as 0.39% (see graph) according to DataExplorers. Korea short interest was 0.42% by August 29. This level is anyway low by international standards – 3% of the S&P 500 is typically out on loan – bringing into question the effect it was anyway having on prices.