Some lawmakers from the ruling Democratic Party (DP) are calling for an extension in the ban on short-selling, which is supposed to be lifted on March 15, in fear of losing votes in the April 7 Seoul and Busan mayoral by-elections. Those individual investors have helped fuel the bullish stock run recently. The lawmakers said that if the financial authorities allow short-selling to resume, it constitutes a dereliction of duty. They insisted the ban should stay intact until negative function of short-selling is addressed entirely. They chant “Fairness in stock market!” and “Relief to anxieties of retail investors!”
However, their claims come from complete ignorance of the stock market fundamentals. The Financial Services Commission (FSC) issued a temporary ban on short-selling due to a sudden shock from Covid-19 which led to foreign capital flight. At the time when stocks crashed, institutional investors used their short-selling leverage to sell stocks and make money. In the meantime, losses ballooned for retail investors who could not afford short-selling strategy.
But the ban on short-selling must not continue. Short-selling is a legitimate strategy that allows an investor to borrow stocks from a stockbroker and sell them to make a profit through repurchase when the price rises. But the function of short-selling does not stop there. Institutional players use it to leverage against risks from a volatile market. Without the leverage, institutional investors overseeing billions of dollars of customers’ money lose protection. Institutions have recently been selling stocks heavily during the bull for that reason. Short-selling can earn money in a downward market, but at the same time covers potential losses from fallen stock prices.
If lawmakers are making such a claim while knowing the functional role of short-selling, they are more or less neglecting the overheated market. As short-selling contributes to removing some of the bubbles in the stock market, it can help stabilize the market. That’s why short-selling is commonplace in all major stock markets around the globe.
The FSC must not waver under political pressure, and it must resume short-selling in March as planned. The 10-year U.S. Treasury bond has been rising sharply after the rollout of vaccines. Temper tantrums could renew if fiscal tightening starts. A greater risk can be made if political reasoning dominates economic and financial policies.