South Korea again failed to obtain the reclassification of its stock market as a developed market by global index provider MSCI after the country reimposed a full ban on stock short selling, which overshadowed positive assessment among foreign investors of the country’s efforts to lower the barrier for access to financial markets here.
According to a statement released last week, Morgan Stanley Capital International recognized and welcomed some of the measures that South Korea has announced with the aim of improving the accessibility of its equity market for foreign investors. It referred to South Korea’s move to allow registered foreign institutions to participate in the onshore interbank foreign exchange market, extend trading hours on the onshore foreign exchange market and ease other requirements on foreign investors.
However, MSCI pointed out that foreign investors were still concerned about the complexity of the revised rules and that additional time is required to assess the implementation of these measures. It also emphasized that participation of companies in some of the voluntary reform measures remained low and that there were issues arising from the limitations on the use of exchange data for financial product creation.
In addition, MSCI categorically drew attention to South Korea’s imposition in late 2023 of a full ban on the short selling of local stocks, citing it as a major obstacle for the country’s attempt to upgrade its stock market into a developed market from the current emerging market status. South Korea recently said it would maintain the ban at least until the end of March next year.
MSCI noted that, while this ban is expected to be temporary, sudden changes in market rules are not desirable. As a conclusion, MSCI said potential reclassifications require that all issues have been addressed, reforms have been fully implemented and market participants have had ample time to thoroughly evaluate the effectiveness of the changes.
The announcement by MSCI provides a valuable lesson for policymakers, not only in South Korea, but in any country adopting a market economy system that intentions or promises alone cannot do much to move investors until their effect is confirmed over time. In addition, investors hate a lack of transparency and predictability even if a country announces promising policy initiatives.
The same principle applies to the government’s "corporate value-up" program, which has drawn a fair amount of suspicion among investors and experts despite the government’s promise that the initiative will help shore up the stock prices of many companies trading at a steep discount despite their fundamental value. In fact, stock prices in South Korea have lagged behind US-listed stocks in recent weeks despite the government’s repeated promises to push ahead with the initiative.
The main South Korean stock market’s Kospi has risen 4.9 percent so far this year while the technology-laced junior market’s Kosdaq index has fallen 1.6 percent. In contrast, the broad US S&P 500 index rose by a larger 14.6 percent over the same period and Japan’s Nikkei 225 index gained 15.3 percent. The sharp contrast not only reflects the difference in the earnings at key companies, but also reflects a difference in the amount of trust investors have toward the markets and policies of the three countries.
In particular, the comparatively sluggish performance of stocks in South Korea clearly shows that the government’s repeated promises about the effect of the value-up program have failed to convince investors despite an initial rally soon after the program was announced in February. Many investors express their disappointment at details of the program that have since been unveiled on several occasions.
For instance, many of the initiatives adopted under the program have turned out to be based on voluntary participation by companies, lacking any legal requirement for companies. Some of the government’s promises require revisions to laws at a time when the ruling People Power Party is far short of a majority in the National Assembly and, therefore, has no power to change any law without cooperation from the opposition parties.
What is more disappointing to the eyes of investors, however, is the fact that companies show little intention to change their management style, especially those belonging to big conglomerates or chaebol. The chairman of a top chaebol has been involved in a divorce lawsuit and the result from it could influence business operations or stock prices at core companies of the chaebol.
The result of the appeals court ruling in the lawsuit has already started to affect stock prices of the group’s core companies on expectation that the chairman may have to sell some of the stakes that he or his family members hold to fulfill the ruling. One company within his group even announced an equity carve-out plan, or physical split, one of the most frequently criticized practices among South Korean companies.
Under the plan, a company sets up a wholly owned subsidiary and transfers core, more profitable business operations to it before listing it on the stock market through an initial public offering. In this process, minor shareholders in the parent company usually suffer from plunges in share prices because the remaining company loses profitable business.
Minor shareholders have the right to sell their holdings back to the company “at a fair price,” but its share prices tend to fall sharply before the announcement is made, resulting in a decline in the price at which minor shareholders can sell their holdings back. Investors and experts have pointed out that this and many other practices, even if not illegal, are the real problem at the center of the Korean discount.
They argue, and I find it difficult to deny, that the corporate value-up program will have only a limited effect as long as these underlying practices continue and unless the attitude of the owning families of companies changes in earnest.
Yoo Choon-sik
Yoo Choon-sik worked as the chief Korea economics correspondent at Reuters and is now a business and media strategy consultant. The views expressed here are the writer’s own. -- Ed.
