South Korea will allow the short selling of large-cap shares from May 3, following heavy criticism from hedge funds and other financial institutions against a year-long ban.

The partial lifting of the measure comes after the local stock market staged a strong recovery following a coronavirus-driven market rout over the past year and was trading at near record highs on the back of heavy retail trading.

“We made the decision to minimise any shock on the market by resuming short selling partially,” Eun Sung-soo, head of the Financial Services Commission, said on Wednesday.

The ban had been scheduled to expire on March 15 but will be lifted for stocks on the benchmark Kospi 200 index and the junior Kosdaq 150 index, after by-elections slated for mid-April, according to the FSC.

But short selling for more than 2,000 companies listed on the market will continue to be prohibited. Lawmakers have demanded tougher screening of illegal short-selling practices and expanding retail investors’ access to stock borrowing.

“It is a compromise because regulators are well aware of the need for short selling but they can’t ignore the public opinion against it,” said Hwang Seiwoon, a researcher at Korea Capital Markets Institute. “Still, it will likely satisfy hedge funds and institutions as short selling had been mostly focused on large-cap shares.”

South Korea is one of only two major Asia-Pacific economies to restrict short selling, along with Indonesia, which will lift its restrictions this month. Seoul’s decision to partially ease restrictions comes amid the growing power of retail investors against short sellers. A group of amateur traders on Reddit, the social media platform, forced huge losses on hedge funds in the US betting against gaming retail chain GameStop in recent weeks.

Hedge funds have said restrictions on short selling lacked rationale as retail investors have become a dominant force, accounting for two-thirds of daily turnover on the country’s $2tn stock market. Heavy retail buying has boosted the Kospi Composite index 48 per cent over the past year, sparking concerns of a bubble in parts of the market such as the pharmaceuticals sector.

South Korean retail investors have piled into popular short targets in recent days including Celltrion, the healthcare company. However, the move probably posed little danger to short sellers, who have long since abandoned their bets against the business.

Retail investors bought a net Won82tn ($73bn) of South Korean shares over the past year while foreign investors sold a net Won30tn of shares, according to data from Korea Exchange, the securities exchange operator.

South Korea has revised rules to toughen penalties for naked short selling, when investors bet that a stock will fall without first borrowing or owning the underlying security. Investors who break the rules could be imprisoned for at least a year or face financial penalties of up to five times any profit they make on a trade.