[Real Estate Finance] Big Event Coming at the End of This Month... Korean Stock Market 'Short Selling Resumption' Warning

Full Resumption of Short Selling After About Five Years...
Past Cases Show Limited Impact
"Expectations for Expansion of Foreign Supply and Demand"...
Retail Investors' Concerns Remain

"The domestic stock market will once again become a playground for short-selling forces."

"The attractiveness of the Korean market will increase. Illegal cases that were problematic before can be detected 99% of the time."

Expectations and concerns are mixed in the domestic stock market ahead of the full resumption of short selling at the end of this month. While there is optimism that foreign investors will return under the newly revamped system, leading to market revitalization, retail investors remain distrustful that illegal short selling can be completely eradicated. Voices expressing concerns about price corrections, especially in stocks that have surged sharply in the short term, are also growing. What impact will this full resumption of short selling have on our capital market?

Full Resumption After About 5 Years... Past Cases Show Limited Impact

According to the financial investment industry on the 5th, short selling, which was banned due to the illegal naked short selling scandal involving global investment banks (IBs) in November 2023, will resume from the 31st. Short selling is an investment method where stocks are borrowed and sold, and if the price falls, they are repurchased to return the shares, thereby earning a price difference. The scope of short selling, which was limited to 350 stocks just before the ban, is expected to expand to all approximately 2,700 stocks this time. The full resumption of all stocks is the first in a full five years since March 2020, during the early stages of the pandemic.

This is expected to have a direct impact not only on overall market sentiment but also on supply and demand. Currently, the short selling balance based on the KOSPI 200 is 3.5 trillion KRW, which has sharply decreased by 72% compared to the ban date (November 6, 2023). Researcher Lee Kyung-soo of Hana Securities predicted a future surge in short selling, saying, "A return to the average is inevitable." When short selling was resumed in May 2021, the short selling balance increased from 4.2 trillion KRW immediately after the ban was lifted to 12.3 trillion KRW within a year.

Looking at past three cases of short selling resumption (October 2008 to May 2009, August to November 2011, March 2020 to April 2021), it is confirmed that market volatility increased immediately after resumption. In 2011, right after the European debt crisis, the KOSPI sharply dropped on the day short selling resumed. However, there was no case where the overall index was dragged down. This is why the securities industry widely expects the impact of this full resumption of short selling to be limited.

Researcher Yeom Dong-chan of Korea Investment & Securities said, "During the first to third short selling ban periods, the Korean stock market showed a favorable performance. Although the first month after resumption showed some weakness, the medium-term performance over three months was good," and evaluated that "(the resumption of short selling) is a factor that expands volatility for about one month." Researcher Shin Min-seop of DS Investment & Securities said, "The dominant prediction is that overvalued stocks could become targets of short selling. Foreign supply and demand should be closely watched," but also analyzed that "the impact will still be limited." There was also a diagnosis that the flow of leading stocks is unlikely to change.

Ultimately, experts agree that fundamentals will be important. Given the nature of short selling, which bets on stock price declines, attention must be paid to earnings and fundamentals. There is also an expectation that stocks with improved earnings following the resumption of short selling will attract net buying, strengthening stock-specific rallies. It could also be an opportunity for revaluation of stocks with excessive price drops.

"Expectations for Expansion of Foreign Supply and Demand"... Retail Investors' Concerns Remain

Experts emphasize that the resumption of short selling is positive for foreign supply and demand. Considering that foreign investor outflows have been cited as a reason for the recent sluggish domestic stock market, the resumption of short selling could be an incentive for their return. It is also noteworthy for Korea that the resumption of short selling will fulfill the conditions for inclusion in the Morgan Stanley Capital International (MSCI) developed market index. Generally, short selling is evaluated as a necessary system in terms of supplying liquidity to the stock market and suppressing bubbles in overheated stocks.

Researcher Na Jeong-hwan of NH Investment & Securities said, "The resumption of short selling can highlight the attractiveness of undervalued stocks," adding, "At the same time, it enables foreign investors to engage in individual stock long-short plays, so an increase in trading volume in the Korean stock market can be expected." He predicted that this stock trading activation effect will be more prominent in KOSDAQ than in KOSPI. Researcher Lee Jae-man of Hana Securities expected, "If the dollar's strength subsides and short selling resumes, the influence of foreigners in the domestic stock market will increase."

However, retail investors' anxiety about the resumption of short selling remains. Although financial authorities are confident that most illegal naked short selling can be detected through the new system, there inevitably remain blind spots such as unregistered cases. This issue was also pointed out at a forum led by the Financial Supervisory Service at the end of last month. The low level of penalties compared to the amounts earned through illegal short selling is also cited as a problem. Financial authorities plan to strengthen monitoring by lowering the criteria for designating overheated stocks for one to two months due to concerns about market impact following the resumption of short selling.