🚨 Analysis of Market-Wide Short Selling Allowance and Its Market Impact
Today Korean Economic News | 2025.02.25
📌 Short Selling to Become Possible for All Listed Stocks
💬 Market-wide short selling will resume after 5 years starting from the 31st of next month. Financial authorities plan to temporarily lower the criteria for designating overheated stocks and strengthen monitoring to mitigate market shock. Concerns about increased stock price volatility intersect with expectations for global fund inflows.
1️⃣ Easy Understanding
Short selling will once again be allowed for all stocks in the stock market. I'll explain what this means and how it will affect investors in simple terms.
Simply put, short selling is an investment method where you "sell borrowed stocks and buy them back later at a lower price." While typical stock investment aims to "buy low and sell high," short selling takes the opposite approach of "sell high and buy low." In other words, it's an investment strategy used when stock prices are expected to fall.
Let me explain with an example: Suppose investor A predicts that the stock price of company B, currently at 100,000 won, will soon drop. A borrows 10 shares of company B from a securities firm and sells them at the current price of 100,000 won, receiving 1 million won. If, as predicted, company B's stock price falls to 80,000 won, A then purchases 10 shares for 800,000 won to return the borrowed stocks, making a profit of 200,000 won (excluding fees).
Until now, short selling in the Korean stock market was only allowed for certain large stocks, such as those in the KOSPI 200 and KOSDAQ 150 indices. However, from the 31st of next month, short selling will be possible for all listed stocks. This means the complete normalization of short selling, which was entirely banned during the COVID-19 crisis in 2020 and partially resumed in 2023.
Financial authorities have decided to temporarily ease the criteria for designating overheated stocks and strengthen monitoring to mitigate market shock from the full allowance of short selling. When a stock is designated as overheated, additional short selling is restricted, which can prevent rapid price drops.
This change has both positive and negative aspects. On the positive side, it increases market efficiency, improves access for global institutional investors to the Korean market, and strengthens price discovery functions. On the negative side, it may increase short-term price volatility and raise concerns about unfair trading due to information asymmetry between individual and institutional investors.
Ultimately, the full allowance of short selling can be seen as institutional progress for the Korean stock market toward becoming an advanced market, but it's a change that requires careful response from market participants in the short term. In particular, individual investors need to understand the short selling mechanism and take a more cautious approach to stock selection and investment strategies.
2️⃣ Economic Terms
📕 Short Selling
Short selling is an investment method where one borrows and sells stocks they don't own, then buys them back when the price falls.
- It's a strategy used when expecting stock price decreases, contributing to price discovery functions and market liquidity supply.
- Unlike regular selling, it requires borrowing stocks, incurring fees and interest costs, and carries the possibility of unlimited losses.
📕 Overheated Stocks
Overheated stocks are those with excessive concentration of short selling, subject to additional regulations.
- Stocks with high short selling ratios or large price volatility over a certain period are designated to promote market stability.
- When designated as overheated, measures such as strengthened uptick rules and short position limits are implemented.
📕 Market Volatility
Market volatility refers to the range of price fluctuations and serves as a measure of uncertainty.
- Higher volatility makes stock price prediction more difficult and increases investment risk.
- Short selling can play a role in reducing volatility, but in the short term, it may increase it.
📕 Global Funds
Global funds are investments that cross national borders and can drive stock prices up when they flow into the domestic market.
- They are diversified across various countries for global portfolio management and move according to the investment attractiveness of each country.
- Allowing short selling can improve global investors' access to the Korean market, potentially having a positive impact on long-term fund inflows.
3️⃣ Principles and Economic Outlook
💡 Background and Significance of Full Short Selling Allowance
The full allowance of short selling in the Korean stock market is evaluated as an important milestone in market advancement beyond simple deregulation.
First, it's necessary to understand the historical context of short selling regulations. Short selling was first introduced to the Korean stock market in 1996 but has gone through several cycles of restriction and allowance. It was completely banned during the 2008 global financial crisis and the 2020 COVID-19 crisis to stabilize the market. In 2023, it was partially resumed for large-cap stocks like those in the KOSPI 200 and KOSDAQ 150 indices. This market-wide allowance is the complete normalization after 5 years since March 2020, reflecting the authorities' judgment on market maturity.
Second, short selling is an important mechanism that contributes to efficient market formation. Short selling serves as a signal to the market when stock prices are judged to be overvalued. This helps reduce information asymmetry and helps stock prices more accurately reflect the actual value of companies. Also, short sellers can convert to buyers in a downward market, contributing to market liquidity supply. In most advanced markets such as the United States, the United Kingdom, and Japan, short selling is recognized as part of normal market function.
Third, it improves global investors' access to the Korean market. Short selling is an important means of portfolio management and risk hedging. If short selling is restricted in the domestic market, global investors may feel constrained in investing in the Korean market, which can lead to weakened global competitiveness of the domestic stock market. The full allowance of short selling is expected to have a positive impact on strengthening the international status of the Korean stock market, such as inclusion in the MSCI (Morgan Stanley Capital International) developed market index.
Fourth, it has significance in terms of the balance between market autonomy and regulation. The full allowance of short selling shows a direction that respects the market's autonomous price discovery function. However, financial authorities are simultaneously implementing measures such as strengthening criteria for designating overheated stocks and improving monitoring systems as safety devices for market stability. This can be seen as an effort to find a balance between market autonomy and stability.
Against this background, the full allowance of short selling is evaluated as an important advancement for enhancing the maturity and international competitiveness of the Korean stock market. However, it also requires efforts to create a fair trading environment and adaptation by market participants following the institutional change.
💡 Impact and Response Strategies by Market Participant
The full allowance of short selling has different impacts on market participants, requiring response strategies tailored to their characteristics.
First, let's look at the impact on individual investors and their response measures. Individual investors may feel anxious in the early stages of short selling allowance as they are at a disadvantageous position compared to institutional or foreign investors in terms of information and capital strength. In particular, individual investors with high investment proportions in small and medium-sized stocks should prepare for the possibility of increased short-term volatility as short selling becomes allowed for these stocks. Response strategies include ① adhering to investment principles focused on company fundamentals, ② strengthening risk management through diversification, ③ careful monitoring of stocks with increasing short selling proportions, and ④ improving understanding of the short selling mechanism. Also, if the investment purpose is long-term, it's important not to overreact to short-term volatility.
Second, institutional investors gain opportunities for new investment strategies. Institutional investors can employ various strategies through short selling, such as portfolio hedging, arbitrage, and performance improvement. In particular, the use of sophisticated investment techniques such as long-short strategies and market-neutral strategies is expected to expand. However, they should be cautious about the possibility of being designated as overheated stocks or receiving market criticism due to excessive concentration of short selling. Institutional investors need to comprehensively review short position management, risk monitoring, and communication strategies.
Third, foreign investors' access to the Korean market improves. Foreign investors have pointed to the limited short selling environment in the Korean market as one of the investment barriers. The full allowance of short selling provides an investment environment that aligns with global standards, which can be an opportunity to expand foreign investors' participation in the Korean market. In particular, investment activities by global hedge funds and quant funds are expected to become more active. This may increase market volatility in the short term, but in the long term, it could lead to positive effects such as improved market efficiency and expanded global fund inflows.
Fourth, small and medium-sized listed companies face new challenges. Small and medium-sized stocks that haven't been subject to short selling until now will be exposed to new market pressure by becoming targets for short selling. In particular, companies with vulnerable financial structures or overvalued stock prices compared to their corporate value may become targets of short sellers. In response, companies need to ① strengthen transparent information disclosure and IR activities, ② maintain stable financial structures, ③ establish sustainable growth strategies, and ④ make efforts to enhance shareholder value. In fact, short selling can act as an external discipline mechanism that increases the transparency and efficiency of corporate management.
As such, the full allowance of short selling has different impacts on each market participant, requiring response strategies tailored to their characteristics and goals. When all participants accurately understand the mechanism and impact of short selling and respond rationally, the efficiency and fairness of the entire market can be improved.
💡 Market Change Outlook Following Full Short Selling Allowance
After the full allowance of short selling, various changes are expected in the Korean stock market, requiring a comprehensive outlook.
First, market volatility may increase in the short term. As short selling begins for small and medium-sized stocks that haven't been subject to short selling until now, the price volatility of these stocks may temporarily increase. In particular, stocks with small market capitalizations and low liquidity may react significantly to small-scale short selling, requiring caution. However, extreme market disruptions are expected to be prevented through financial authorities' strengthened criteria for designating overheated stocks and improved monitoring systems. In the medium to long term, volatility is expected to stabilize with the adaptation of market participants.
Second, the stock lending market is expected to be activated, and related infrastructure is expected to develop. The full allowance of short selling will increase the demand for stock lending, promoting the growth of the related market. This has the effect of creating new revenue sources such as stock lending fees and interest income, and increasing market liquidity. Also, the development of related services and systems such as lending brokerage, collateral management, and risk monitoring is expected. In particular, opportunities for income generation through stock lending are expected to expand for individual investors as well.
Third, diversification of investment strategies and improvement of market efficiency will occur. Short selling allowance enables various investment strategies beyond simple buying strategies, such as long-short, market-neutral, and arbitrage. This has the effect of increasing market information efficiency and reducing price distortions. Also, it can enhance the accuracy of corporate valuation by playing a check-and-balance role for overvalued companies. In the long term, it will be an opportunity to increase investor expertise and market maturity.
Fourth, it will affect global investors' evaluation of the Korean market and fund inflows. The full allowance of short selling is a measure that increases the Korean stock market's compliance with global standards, which can enhance international investors' accessibility and confidence in the Korean market. This is expected to have a positive effect on strengthening the international status of the Korean stock market, such as inclusion in the MSCI developed market index. However, in the short term, other factors such as the global macro environment and domestic corporate performance outlook may have a greater impact on fund flows, so the effect of short selling allowance is likely to appear gradually and over the long term.
Fifth, institutional evolution for investor protection and ensuring market fairness will continue. Along with the full allowance of short selling, institutional supplements for market stability and investor protection are expected to continue. Financial authorities are seeking to ensure market stability through measures such as strengthening criteria for designating overheated stocks, improving illegal short selling monitoring systems, and mandating borrowed short selling. In the future, institutional evolution such as transparent information disclosure, strengthened short position reporting systems, and improved access to short selling for individual investors is expected to continue.
Overall, the full allowance of short selling is evaluated as an important change that contributes to the advancement and efficiency improvement of the Korean stock market. While there may be some confusion and increased volatility in the short term, it is expected to lead to qualitative growth and strengthened global competitiveness of the market in the long term. However, to maximize these positive effects, continuous institutional improvements to create a fair and transparent trading environment must be supported along with the adaptation of market participants.
4️⃣ In Conclusion
The allowance of short selling for all stocks in the market is an important advancement for the sophistication of the Korean capital market and its alignment with global standards. The complete normalization after 5 years is expected to bring various positive effects such as strengthening the market's price discovery function, diversifying investment strategies, and improving global investor accessibility.
In the short term, market volatility may increase, especially centered on small and medium-sized stocks. In response, financial authorities have stated their policy to strengthen criteria for designating overheated stocks and to conduct thorough monitoring. They also aim to prevent market disruption by strengthening surveillance and sanctions against illegal short selling. These safety measures will help mitigate the shock from the full allowance of short selling.
Individual investors need to increase their understanding of the short selling mechanism and more thoroughly analyze the fundamentals of their investment stocks. It's important to adhere to investment principles from a long-term perspective rather than overreacting to short-term volatility. Also, there's a need to strengthen risk management through diversified investment and monitoring of short selling trends.
For institutional and foreign investors, opportunities to employ various investment strategies are expanded. In particular, they can pursue profits regardless of market conditions through strategies such as long-short and market-neutral. This will contribute to increasing market efficiency and reducing price distortions.
For listed companies, it becomes even more important to gain market trust through transparent information disclosure and sustainable growth strategies. Short selling can act as an external discipline mechanism that increases the transparency and efficiency of corporate management, which can have a positive effect on enhancing corporate value in the long term.
In conclusion, the full allowance of short selling presents both challenges, such as increased short-term volatility, and opportunities, such as strengthening the global competitiveness of the Korean stock market and improving market efficiency. For these changes to work in a positive direction, mature responses from all market participants and continuous institutional improvements to create a fair and transparent trading environment are necessary. It is hoped that the Korean stock market will develop into a more mature and efficient market with this change as a catalyst.