South Korea short-selling resumption set to entice global funds

As South Korea prepares to lift a 17-month ban on short selling, market watchers are expressing confidence that long-term benefits from the resumption of the popular trading practice will far outweigh any near-term volatility.

Come Monday (Mar 31), the US$1.7 trillion market will once again be open for short-selling strategies used by hedge funds and global investment banks. That’s expected to boost overall liquidity and help the country’s bid to be upgraded to developed status from emerging in MSCI’s equity gauges, as the index provider has called for improving access for foreign investors.

“This is a highly meaningful event that would make South Korea an investable market again to global investors,” said Jung In Yun, chief executive officer at Fibonacci Asset Management Global in Singapore. “South Korea will become a more mature market.” 

Several firms, including Pictet Asset Management, have said they plan to buy more Korean shares once the ban is lifted. Amundi expects the market to extend recent gains even after short sellers are allowed again. Citigroup analysts earlier this month raised the firm’s target for the stock benchmark Kospi by roughly 4 per cent. 

“We see the lift of short-selling ban as an upside catalyst for Kospi, as we expect the lift would lead to an increase in market liquidity driven by foreign investment,” Citi analysts including Peter Lee said in a note. 

South Korean authorities had previously tried partial banning before the latest iteration in November 2023 that fully prohibited short selling of shares for all listed companies. Starting Monday, investors can sell borrowed shares of all of the roughly 2,800 stocks traded in Seoul. 

In enacting the ban in 2023, authorities cited unlawful trades, particularly what they called “rampant” naked short selling, and the need to restore fairness for retail investors. Regulators have since investigated and penalised global banks.

Naked short selling – or the practice of selling shares without borrowing them first – will remain illegal as it had been a key catalyst for the ban. An electronic monitoring system to detect such trades will also go online from Monday.

Short selling accounted for roughly 5 per cent of total Kospi turnover in 2023 before the ban in November that year, according to exchange data calculated by Bloomberg.

MSCI bid 

A series of dominoes could fall once short selling is resumed. 

Heightened volatility is likely in the near term, said Yi Ping Liao, a portfolio manager at Franklin Templeton Emerging Markets Equity. But if companies make progress on governance and shareholder returns – as called for by the government-sponsored “Value-up” campaign – the so-called “Korea discount” of stock prices may narrow further as short selling returns, she said.

South Korea’s Kospi is already Asia’s second-best performer among major Asian equity gauges this year, with a roughly 7 per cent gain. However, global investors have largely sat out the rally so far, offloading about US$20 billion in South Korean stocks since August amid the country’s political turmoil triggered by a short-lived martial law decree. 

The government will likely “re-accelerate” efforts to be upgraded by MSCI in the medium term, Citigroup’s analysts wrote, adding the index compiler may add South Korea to its watch list in either June 2025 or June 2026 before upgrading it as a developed market a year later. MSCI didn’t respond to requests for comment. 

One area that may see a pick-up in activity along with the end of the ban is the issuance of convertible bonds, which has largely dissipated in the last few quarters. The resumption of short selling would allow a popular strategy that involves buying the debt while shorting the underlying stock. 

Short-selling bans by various countries following the 2008 financial crisis were detrimental for liquidity, especially for small cap stocks, and failed to support prices, according to a research published in the Journal of Finance in 2012. 

Short Targets

Some of the best known and heavily traded stocks will potentially experience volatility. Samsung Electronics, the nation’s largest company, will be a major target given its shares’ recent upturn and doubts about its global leadership position in technology, analysts said.   

“I think Samsung Electronics will be the first one to get the shorts,” said Peter Kim, head of global business group at KB Securities. “My investors are worried about its technological lead that it used to enjoy.”  

Electric vehicle battery makers and related names, such as Samusng SDI, Ecopro and Posco Future M, also have been bandied about as potential short targets given their valuations.

There is “a potential for a tactical short squeeze” in the sector after the ban lifts, Goldman Sachs analysts including John Kwon said in a recent note. BLOOMBERG