South Korea
07 August 2012
In the second part of a two part series on South Korea, SLT talks to Dane Fannin and Sunil Daswani of Northern Trust about the effects of short selling bans as a means of boosting financial recovery
Image: Shutterstock
Short sellers continue to have a difficult time globally as governments and regulators try to boost financial recovery. Short selling bans have been implemented and lifted throughout Europe and Asia since the financial crisis hit in 2007, with Spain and Italy being the latest countries to reintroduce bans on a practice that is important to many securities lending strategies.
South Korea implemented a ban on short selling in October 2008, but lifted the ban on non-financial stocks in June 2009. It then banned short selling on all listed stocks again in August 2011. The short selling ban was lifted for non-financial stocks in November 2011, but financial stocks continue to be banned from short selling.
SLT talks to Sunil Daswani, Northern Trust’s head of international client relations for securities lending, and Dane Fannin, Northern Trust’s head of equity trading in the Asia Pacific region, about short selling in South Korea and the effect that bans have had on the market.
What is the current situation is South Korea?
Dane Fannin: Much of the offshore securities lending demand is being driven by market neutral equity long and short hedge funds that typically employ fundamental analysis to identify over and undervalued securities. There are also various statistical arbitrage strategies that are employed to take advantage of the relative mispricings between securities on a time series method, although these are less common. To our knowledge, there have been no offshore hedge funds that have established an onshore presence to tap into the domestic space, despite recent regulation to allow this. However, we are aware of the presence of local hedge funds, although offshore prime brokers are unable to service such clients given the lack of local presence, which requires substantial capital outlay.
What role does short selling play in a sec lending strategy?
Sunil Daswani: It’s important to recognise that although one supports the other, securities lending and short selling are two entirely different activities, despite being commonly interchanged. A short sale is typically the second leg of a hedging strategy that is employed to generate a return by seeking to profit from an arbitrage opportunity between two mispriced assets or sectors, for example. Without the ability to borrow the security and subsequently short sell, the trade is entirely exposed to market risk and so may be too risky to pursue. It should also be said that short selling plays an important role in providing the market with liquidity and efficient price discovery.
Why and how did South Korea ban short selling?
Fannin: Although the correlation between a falling stock market and short sale volumes has not been established, regulators remain cautious, particularly in light of the Asian financial crisis.
In August last year, the South Korean regulator imposed a three-month covered short sale ban for all securities amid broader market volatility and concerns over a falling stock market, which was believed to have been driven in part by short sellers. The ban was lifted in November 2011 for non-financials only and a naked short sale ban remains in place indefinitely for all securities.
What effect have short selling bans had on hedge funds and other borrowers in South Korea?
Daswani: Despite existing rules as well as the risk of further short sale bans in future, and the difficulty in hedging against such regulation, South Korea remains an attractive market in terms of returns to beneficial owners. While volumes are perhaps lower than they would be if the ban on financials were lifted, investors are likely to continue trading albeit with added caution. We see this theme in other emerging Asian markets, including Taiwan, in which revenue prospects outweigh the risk of punitive regulation. It is these markets that remain the key focus for agent lenders and their clients as the region continues to grow.
If the short selling bans are not lifted, what else could be done to attract hedge funds and other borrowers to South Korea?
Fannin: Ultimately, it is the broader economic environment that is challenging the potential growth in South Korea, and indeed in other locations around the globe. Hedge funds are unlikely to be convicted until volatility subsides and correlation returns. In the short run, however, more regulatory transparency would certainly benefit the wider investor audience in South Korea as this would likely instill confidence and encourage investors to deploy additional capital in the market. Conversely, it is equally important for market participants to work closely with regulators to ensure the operation of efficient markets while preventing market manipulation or abuse and avoiding any unintended consequences.
South Korea implemented a ban on short selling in October 2008, but lifted the ban on non-financial stocks in June 2009. It then banned short selling on all listed stocks again in August 2011. The short selling ban was lifted for non-financial stocks in November 2011, but financial stocks continue to be banned from short selling.
SLT talks to Sunil Daswani, Northern Trust’s head of international client relations for securities lending, and Dane Fannin, Northern Trust’s head of equity trading in the Asia Pacific region, about short selling in South Korea and the effect that bans have had on the market.
What is the current situation is South Korea?
Dane Fannin: Much of the offshore securities lending demand is being driven by market neutral equity long and short hedge funds that typically employ fundamental analysis to identify over and undervalued securities. There are also various statistical arbitrage strategies that are employed to take advantage of the relative mispricings between securities on a time series method, although these are less common. To our knowledge, there have been no offshore hedge funds that have established an onshore presence to tap into the domestic space, despite recent regulation to allow this. However, we are aware of the presence of local hedge funds, although offshore prime brokers are unable to service such clients given the lack of local presence, which requires substantial capital outlay.
What role does short selling play in a sec lending strategy?
Sunil Daswani: It’s important to recognise that although one supports the other, securities lending and short selling are two entirely different activities, despite being commonly interchanged. A short sale is typically the second leg of a hedging strategy that is employed to generate a return by seeking to profit from an arbitrage opportunity between two mispriced assets or sectors, for example. Without the ability to borrow the security and subsequently short sell, the trade is entirely exposed to market risk and so may be too risky to pursue. It should also be said that short selling plays an important role in providing the market with liquidity and efficient price discovery.
Why and how did South Korea ban short selling?
Fannin: Although the correlation between a falling stock market and short sale volumes has not been established, regulators remain cautious, particularly in light of the Asian financial crisis.
In August last year, the South Korean regulator imposed a three-month covered short sale ban for all securities amid broader market volatility and concerns over a falling stock market, which was believed to have been driven in part by short sellers. The ban was lifted in November 2011 for non-financials only and a naked short sale ban remains in place indefinitely for all securities.
What effect have short selling bans had on hedge funds and other borrowers in South Korea?
Daswani: Despite existing rules as well as the risk of further short sale bans in future, and the difficulty in hedging against such regulation, South Korea remains an attractive market in terms of returns to beneficial owners. While volumes are perhaps lower than they would be if the ban on financials were lifted, investors are likely to continue trading albeit with added caution. We see this theme in other emerging Asian markets, including Taiwan, in which revenue prospects outweigh the risk of punitive regulation. It is these markets that remain the key focus for agent lenders and their clients as the region continues to grow.
If the short selling bans are not lifted, what else could be done to attract hedge funds and other borrowers to South Korea?
Fannin: Ultimately, it is the broader economic environment that is challenging the potential growth in South Korea, and indeed in other locations around the globe. Hedge funds are unlikely to be convicted until volatility subsides and correlation returns. In the short run, however, more regulatory transparency would certainly benefit the wider investor audience in South Korea as this would likely instill confidence and encourage investors to deploy additional capital in the market. Conversely, it is equally important for market participants to work closely with regulators to ensure the operation of efficient markets while preventing market manipulation or abuse and avoiding any unintended consequences.
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