[Insight & Opinion] Banning Short Selling and Restoring Trust in the Stock Market

Volatility Increases, Advanced Market Status Slips Further Away
Reforms Needed That Reflect Korea’s Unique Market Conditions

Jacob Little (1794?1865), who dominated Wall Street in the United States for over 20 years, is known as a legend of short selling. He selected overvalued stocks to short sell, spread false information about those stocks to drive down their prices, and was called a bankruptcy prophet and a spreader of distrust. However, he eventually squandered his fortune and died penniless, completely shunned by the financial community.

The financial authorities have taken the drastic step of banning short selling. The stock market’s trust plummeted to rock bottom due to the stock price manipulation scandals involving Young Poong Paper and Daeyang Metal. The fact that global investment banks conducted illegal short selling worth 56 billion KRW domestically also fueled public outrage. Short selling is a system where stocks are borrowed in advance and sold; if the price falls, the seller profits, but if it rises, they incur losses and must return the stocks. Naked short selling, where orders are placed without borrowing stocks beforehand, is illegal and must be severely punished to prevent recurrence.

It is natural for investors to complain when the market is difficult. When stock prices fell sharply in October, short selling became the target of public resentment. This is understandable since the main short sellers are foreigners (74%), institutions (24%), and individuals (less than 2%). Looking at the proportion of short selling by trading entity, it is easy to sympathize with individual investors’ anger toward short selling.

During the 2008 global financial crisis, the 2011 European debt crisis, and the 2020 COVID-19 shock, comprehensive bans on short selling were implemented to curb market volatility and investor anxiety. Short selling is a risky investment because the direction of stock prices is uncertain, but it can yield profits when the market trends downward. The justification for protecting the domestic market, often regarded as a playground for foreigners, is left undecided.

Some have compared the government’s recent measure to burning down a thatched cottage to catch a flea. Jim Rogers, one of the world’s top three investors alongside Warren Buffett and George Soros, criticized the Korean government’s short selling ban as a mistake and an obstacle to becoming a major international financial hub.

A public petition demanding improvements to the short selling system has already surpassed 50,000 signatures. Last year, the number of individual investors holding shares in domestic listed companies exceeded 14 million. The government could no longer ignore the situation. Institutions that wrote exaggerated reports and short sold to induce stock price declines deserve condemnation. Implicit information sharing on stocks involving long (buy) and short (sell) plays between institutions is also problematic. Collusion with black-haired foreigners residing overseas must be eradicated.

Equalizing the repayment period and collateral ratio for borrowed short selling between institutions and individuals, and computerizing short selling transactions, have become key issues in improving the short selling system. These stem from misunderstandings of the system or reality. Despite being based on the international standard terms for securities lending, incorrect information spreads online, leading to discussions of legislative proposals.

The important issue is how to improve individual investors’ relatively limited access to short selling compared to foreigners and institutions, bridging the gap considering foreign cases and Korean realities. The sudden ban on short selling has rather intensified market volatility and delayed the stock market’s inclusion among advanced markets. Implementing such measures without notice undermines predictability. Public opinion that investors should have been given a chance to close out their buy and sell positions must also be considered. This opportunity should prompt us to seriously reflect on why our stock market remains classified as an emerging market, unworthy of our national stature. The stock market is a function of profit and liquidity, not short selling. We must not be trapped by the cheers and frustrations of retail investors. Efforts to build a better capital market in Korea are essential to restoring trust.

Wonkyung Cho, Professor at UNIST, Director of the Global Industry-Academia Cooperation Center

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