[Why&Next] Short Selling Resumption Imminent... Focus on Loan Balance Trends

Short Selling Ban to Be Lifted on All Stocks from the 31st
Prepare for the System Blocking Naked Short Selling
Monitor Loan Balance Trends by Stock

The 'sore spot' of the Korean stock market, short selling, is making a comeback. With the full lifting of the short selling ban, which lasted for the longest period in history, investors are divided between anticipation and concern. As the newly introduced Short Selling Detection System (NSDS) makes securing pre-borrowed shares the key to short selling investment, experts recommend paying close attention to the flow of loan balances by stock.

According to the financial investment industry on the 25th, short selling of listed stocks will resume from the 31st. This comes about 17 months after a complete ban was imposed in November 2023 to eradicate naked short selling. Compared to the previous three bans (in 2008, 2011, and 2020), this is the longest period in history. The scope of short selling, which was limited to 350 stocks just before the ban, will be expanded to all stocks for the first time in about five years since March 2020, the early stage of the pandemic.

Will NSDS Resolve Distrust in Short Selling?

Short selling is an investment technique where an investor borrows shares they do not own from securities firms or institutions, sells them, and then repurchases them at a lower price if the stock price falls, returning the borrowed shares to earn a profit from the price difference. The problematic 'naked short selling' refers to illegal short selling conducted by global investment banks (IBs) exploiting system loopholes without actually borrowing the shares.

In Korea, opinions on short selling have been sharply divided. The investment and academic sectors generally emphasize the positive role of short selling in correcting overvalued stock prices and injecting liquidity into the market, but individual investors have a distinctly negative perception of short selling. This is because short selling can cause stock prices to fall and may be abused for unfair trading.

Provided by Korea Exchange

In response, financial authorities have increased penalties for illegal short selling activities and introduced the Naked Short Selling Detection System (NSDS) to restore investor trust. From the 31st, corporations and market makers or liquidity providers with a net short position of 0.01% (excluding amounts under 100 million KRW) or more than 1 billion KRW in any single stock must have their own inventory management systems to block naked short selling orders in real time.

The 'tilted playing field' between institutional investors and individual investors regarding access to short selling will also be normalized. The repayment period for borrowed listed shares for short selling purposes by institutional investors is limited to within 90 days (extendable up to 12 months), and the collateral ratio applied to individual investors using margin lending services will be lowered to 105%, the same as that for institutional investors' securities lending transactions.

The Key is Securing Borrowed Shares

The strengthened short selling system focuses on preemptively blocking naked short selling by verifying the available loan balance for institutional investors. In other words, if sufficient shares are not borrowed in advance, short selling is impossible. Sujin Han, a researcher at Samsung Securities, said, "Although short selling is now possible for all stocks, in practice, short selling will concentrate on stocks where borrowed shares can be secured," urging attention to stocks with increased loan balances over the past month.

As securing shares in advance for short selling becomes crucial, institutional investors are also actively moving. Daejun Kim, a researcher at Korea Investment & Securities, noted, "Based on closing prices as of the 21st, the one-month stock price trend by stock shows that loan balances mostly have a positive (+) direction," adding, "Despite a generally challenging environment for stock price increases recently, the rise in stock prices can be seen as influenced by proactive buying for securities lending."

Individual investors should first check whether the loan balance is increasing if the stock prices of the stocks they hold are rising. Historically, when the loan balance ratio relative to listed shares exceeds 3%, the probability that loaned shares will be converted into short selling volume increases, according to researcher Kim. He added, "If the loan balance ratio of the stocks you hold exceeds 5%, and the 12-month forward earnings per share (EPS) growth rate is lower than the market or the 12-month forward price-to-earnings ratio (PER) is significantly higher than the market average, caution is needed."

Among companies with a market capitalization of 2 trillion KRW or more and a loan balance ratio of 3% or higher relative to listed shares on the KOSPI, those whose loan balances doubled in the past month (February 21 to March 21) include Isu Petasys, HD Hyundai Mipo, and Hanmi Semiconductor. On the KOSDAQ, companies with a market cap of 300 billion KRW or more and a loan balance ratio of 3% or higher whose loan balances have surged in the past month include Juseong Engineering, Komico, and Nextin.

"Short Selling Volatility is an Opportunity, Not a Risk"

While short-term uncertainty in supply and demand due to short selling may increase stock price volatility, there is also a view that it can be an opportunity for bargain buying. If investors believe the stocks they hold have long-term growth potential, they can adopt a strategy of increasing their holdings by lowering the average purchase price despite short selling pressure.

Researcher Taeyun Sun of KB Securities said, "After the past three resumptions of short selling, the one-month index returns were sometimes affected, but the three-month returns generally stabilized," adding, "Companies that have risen excessively relative to earnings and growth stocks may become targets of short selling, but factors such as global liquidity, domestic and international economic conditions, corporate earnings, and political variables will have a greater impact than the resumption of short selling itself. In the mid to long term, differentiated stock price trends will appear depending on whether earnings forecasts are revised upward."