[Inside Chodong] Concerns Over the 'Political Use' of Short Selling

Backlash Over "Short Selling Suspension for Election"
Politicization Leads to Regression in Capital Market Advancement

Jungsoo Lim, Deputy Head of Securities Capital Markets Division

Short selling is a transaction where stocks are borrowed and sold. Investors often resent short selling, which harms stock prices, especially since they sell borrowed stocks they do not own. Recently, amid the plunge in secondary battery stocks, short selling has become the main culprit behind the stock price decline for retail investors. However, short selling plays an important market function in the stock market. It enhances the market’s ‘price discovery function’ through balancing liquidity on both the demand and supply sides. The principle is that when abundant demand and supply achieve balance on both sides, the market’s most important value, the price discovery function, operates properly.

Market supply and demand are fundamentally based on demand from investors who want to buy stocks with available cash and supply from investors holding stocks who want to sell them. Added to this are mechanisms that increase market liquidity: demand from those who borrow money (on margin, credit, loans, etc.) to buy stocks, and supply from those who borrow stocks to sell (short selling). Short selling acts as a kind of balancing weight on the supply side, complementing liquidity against demand-side liquidity from borrowing money to buy stocks. If liquidity on one side disappears and balance is broken, stock prices are likely to move excessively in the other direction.

Analyses by experts support this. The Korea Capital Market Institute analyzed past cases of complete short selling bans in Korea and found that banning short selling reduced the efficiency of price determination in the stock market. They also explained that stock price volatility increased and the frequency of excessive price rises beyond fair value grew. This indicates that overvaluation of stock prices was not well resolved when short selling was restricted. Conversely, after resuming short selling, volatility decreased, the frequency of excessively high returns declined, and trading turnover increased, showing positive effects.

Short selling also helps prevent stock price manipulation. Large-scale stock manipulation cases, such as the ‘Ra Deok-yeon incident,’ always began by excessively driving up the price of targeted stocks. Most of the stocks targeted by these criminals did not allow short selling, making it relatively easy to raise prices with small volumes of trading. If short selling had acted as a balancing weight, excessive price increases would not have occurred, and investor damage might not have grown so large. Initially, the Ra Deok-yeon group might have recognized that it was difficult to easily drive up prices and thus might not have attempted stock manipulation so readily.

Kim Ju-hyun, Chairman of the Financial Services Commission, has repeatedly emphasized the positive functions of short selling in public. It is questionable whether the current short selling situation is so severe as to warrant a suspension, especially since he declared a halt to short selling contrary to his usual ‘market-oriented’ philosophy. This is why interpretations abound that political pressure from the ruling party (People Power Party) influenced the short selling ban declaration. Major domestic and international media unanimously interpret it as an election strategy by the People Power Party in preparation for next year’s general election. It is seen as a way to win retail investors’ votes following the incorporation of Gimpo City into Seoul.

However, the market’s evaluation of the short selling suspension is not favorable. The strategy to incorporate Gimpo City into Seoul has sparked backlash from people outside Gimpo, and the short selling suspension has drawn criticism from rational market-oriented conservatives. There are concerns that the conservative party, which should adhere to market principles, has set a precedent of politically exploiting short selling. The politicization of short selling may only slow the advancement of Korea’s capital markets.

This content was produced with the assistance of AI translation services.