A currency trader watches monitors at the foreign exchange dealing room of KEB Hana Bank headquarters in Seoul
South Korean regulators introduced a blanket ban on short selling on November 6 in response to so-called naked short selling, which authorities said had ‘undermined fair price formation’ in the country’s markets © Ahn Young-joon/AP

Global investment banks have criticised a blanket ban on short selling imposed by South Korean regulators last week, accusing authorities of bowing to the demands of local retail investors ahead of parliamentary elections in April.

The ban, which came into force on November 6 and is due to last until June next year, was introduced as a response to so-called naked short selling, which financial authorities said had “undermined fair price formation” in South Korea’s capital markets.

Regulators added that they were setting up a task force to investigate illegal short selling practices by “about 10” international banks.

But representatives of two global investment banks with a presence in South Korea told the Financial Times that regulators were deliberately conflating illegal and legal short selling practices to appease voters.

A representative of one of the banks, who spoke on the condition of anonymity because of the ongoing investigations, said regulators had created a “bogeyman” and a “phantom farce”. They said the short selling ban would make it harder to properly value listed companies and would deter international investors.

“[In South Korea] investors are investors, but they are also voters,” a senior executive from another bank said, noting that local retail investors account for roughly two-thirds of the turnover in South Korean capital markets, compared with about 10 per cent in Japan and Hong Kong, according to industry estimates.

Both said the ban would undermine the country’s longstanding ambition to be upgraded to developed market status by leading index providers. “Ultimately, it’s just going to be very negative for Korean companies,” one of them said.

Changhwan Lee, founder of Seoul-based activist hedge fund Align Partners Capital Management, noted the MSCI had said in the past that South Korea’s restrictions on short selling were a barrier to its inclusion in the index provider’s developed market index.

“Short selling should be allowed because it helps prevent stock price bubbles,” said Lee. “It is a global standard. But retail investors have emerged as a powerful voting bloc, so the government could not ignore their demands.”

South Korean regulators in October said they planned to impose fines on two global investment banks, which they have not publicly identified, over “routine and intentional” naked short selling. Naked short selling is the illegal practice of short selling shares without first borrowing them or confirming they can be borrowed.

HSBC and BNP Paribas are the two banks facing fines, said several people with knowledge of the situation. HSBC and BNP Paribas declined to comment.

An official from South Korea’s Financial Supervisory Service said while “there could have been human or system errors in some cases, there are more grave cases”.

“Naked short selling has been done for not just a couple of stocks but for numerous stocks for a long time,” said the official, who spoke on condition of anonymity, citing the ongoing investigation into the banks.

Local retail investors who have long demanded a blanket ban on short selling are jubilant.

“The ban will boost stock prices,” said Jung Eui-jung, head of the Korean Stockholders Alliance, an advocacy group. “Short selling has been the most widely used tool for foreigners and institutions to steal the assets and rob the wallets of 14mn retail investors.”

But Chan Lee, managing partner at Seoul-based hedge fund Petra Capital Management, noted the benefit to share prices from the ban had been fleeting.

South Korea’s benchmark Kospi index jumped almost 6 per cent on the first trading day after the ban was announced, but it has since fallen about 4 per cent from that peak.

“Naked short sellers need to be punished, but it doesn’t make sense to put a blanket ban on short selling just for this reason,” said Petra Capital’s Lee.

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