Total Short-Selling Ban Is a Step Too Far

The Korea Composite Stock Price Index and the junior Kosdaq surged five to seven percent on Monday after the government announced a complete ban on short selling until June next year. Short selling, where a trader borrows shares they do not own to sell in expectation that the price will fall, is practiced in most countries. It can wreak enormous damage when markets panic, and calls have increased among retail investors here for the practice to be regulated. 

Many countries ban short selling when their stock markets plummet dramatically. Korea implemented temporary bans during the 2008 global financial crisis, the 2011 eurozone fiscal crisis and the 2020 coronavirus pandemic. But it is extremely rare for the government to ban short selling at times that are not deemed to be a crisis. But one month after global investment banks were caught in illegal short-selling practices, the government promised to "rectify systemic weaknesses" favoring foreign and institutional investors, but many people believe it is merely trying to woo voters ahead of the general elections in April next year.

Short selling was widely criticized by retail investors when the domestic stock market turned bearish this year, and stock prices surged on the first day of the ban as retail investors welcomed the measure while foreign investors hastily covered themselves by snapping up Korean stocks. But studies show that such a ban has no long-term effect in boosting stock prices. Banning the practice also entails a greater risk of stock-price manipulation -- most cases of manipulation found recently involved shares that were not allowed to be shorted, since shorting can be a useful corrective to overhyped stocks. The ban also weakens the chances of Korea's bourse being included among advanced stock market groups. 

The current system does have its flaws. At present, it is impossible to distinguish a "naked" short-selling trade, involving the sale of shares without first borrowing them or confirming that they can be borrowed, which is illegal in Korea. Also, collateral ratios and debt-repayment periods currently being enforced are criticized for favoring foreign and institutional investors. But people caught engaging in illegal short selling get only a slap on the wrist. But now the ban is in place, the government should have used the opportunity to fix these weaknesses of the system and ensure that legitimate short-selling can resume without being abused.