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| Hwang Sei-woon, research fellow at Korea Capital Market Institute |
Gov't urged to target those exploiting short selling rules
By Hwang Sei-woon
Since March 16, the financial authorities here have temporarily banned short-selling on the Korea Exchange. As the coronavirus pandemic raised concerns about a global economic recession, investors were terrified and the stock market panicked. In response to the stock price crash, the financial authorities decided to temporarily ban short selling for six months.
Short selling is still exceptionally available for market makers on the Korea Exchange. However, considering criticism from retail investors, it seems that the authorities are inducing the market makers to shorten their short selling activities.
On the Seoul stock market, there is an ongoing controversy over short selling. Many retail investors have consistently insisted on its abolition, while academics and those in the industry have pointed out the need for it.
Academics widely agree on the need for short selling because it provides an important route to reflect negative information on share prices and can play a role in increasing market liquidity. On the other hand, retail investors are petitioning for the prohibition of short selling, which they argue is the main culprit of the fall in stock prices.
Most academic research papers recognize the positivity of short selling. It is repeatedly reported that short selling is only a trading strategy that can produce profit when the stock price declines, and short selling itself is not the core reason for falls in stock prices. However, retail investors disagreed with this, and many even argue that banning short selling will stop stock prices from falling.
It is clear that prohibiting short selling will not be able to stop stock prices from falling. The stock price reflects the company's fundamentals. The stock prices are declining because the stock market is now driven by concerns over a global economic downturn caused by the coronavirus pandemic. As both household consumption and corporate production have contracted extremely, an overall contraction in the first and second quarters are inevitable. Companies' sales have fallen sharply and the likelihood of an operating deficit has increased. This would be the primary reason for the current stock price drop.
Banning short selling does not solve the contraction of consumption and production caused by the coronavirus. Therefore, the ban on short selling cannot be an effective policy measure which prevents the stock price from falling. It should be noted that even after the ban on short selling in October 2008, stock prices still plummeted.
In order to resolve the short selling controversy, the financial authorities need to focus on strengthening financial penalties for unfair trading practices that exploit short selling and improving accessibility to short selling by retail investors.
Due to the coronavirus, everyone is suffering from pain. It is not desirable to consume precious time on such a debate as banning short selling. We will have to concentrate our resources on coming up with a more productive solution to overcome this painful crisis.
