Vice chair Kim So-young of Korea’s Financial Services Commission (FSC) attended a meeting on short selling reform measures which brought together authorities from the private sector, the ruling party of the National Assembly and the government. The authorities discussed a direction for making improvements to the short selling system. The FSC had recently imposed a temporary ban on stock short selling until end of June 2024.
Overall, the proposed measures are aimed at (a) leveling the playing field between institutional and retail investors, (b) preventing naked short sales in advance, (c) strengthening the detection and punishment of illegal short selling activities, and (d) expanding short sale disclosure.
Leveling the playing field
Currently, the stock borrowing conditions for short selling remain unequal between institutional investors and retail investors, although the gap has been narrowed considerably through past reform measures for retail investors, extending the stock repayment period from 60 days previously to 90 days and lowering the margin requirement from 140 percent previously to 120 percent. However, the discrepancies in stock lending still exist and this has been raised as a problem of unleveled playing field for retail investors vis-à-vis institutional investors.
As a way to resolve this problem, the authorities propose making the stock repayment period and margin requirement same for both institutional investors and retail investors. More specifically, first, the stock repayment period for institutional investors — currently unrestricted and determined on a contract-by-contract basis — will be set as 90 days, same as that for retail investors.
The Korea Securities Depository, which handles stock lending to institutional investors, should check the repayment period on transaction contracts. When a stock borrowing transaction is found to be in violation of the repayment period, an administrative fine (KRW100 million – $77k) may be imposed on the trader.
Second, the margin requirement (collateral ratio) for retail investors—currently at 120% for cash collateral—will be reduced to 105%, same as that for institutional investors, while the collateral ratio for KOSPI200 stocks will remain the same as the current level at 120%.
Preventing naked short sales in advance
The Financial Investment Services and Capital Markets Act (FSCMA) prohibits naked short selling, and securities companies are required to submit short sale orders after verifying that they are covered short sales. However, naked short selling takes place routinely due to some loopholes in management on short positions and internal control by institutional investors and the verification procedure by securities firms.
To address this problem, institutional investors will be required to set up an internal computing system for managing their short positions and relevant standards for internal control. An exemption may be granted to institutions engaging in short selling only in small scale below the threshold for short sale reporting requirement or those submitting proof of stock borrowing every time they place short sale orders at securities firms. As of 2023, about 21 foreign institutions and 78 domestic institutions, which account for about 92% of all short sale transactions, are expected to come under this requirement.
The internal computing system will allow institutional investors to manage their short positions, preventing them from placing short sale orders exceeding their short positions or prior to borrowing stocks. Moreover, all institutional investors engaging in short selling activities will be required to establish internal control standards aimed at preventing naked short selling. In this regard, securities companies will be obliged to check institutional investors’ internal systems prior to allowing them to submit short sale orders and report their verification results to the Financial Supervisory Service (FSS). An administrative fine may be imposed on violation of these requirements. Additionally, the FSS and the Korea Exchange (KRX) will look into the possibility of building an external system that can block naked short selling in real time.
Strengthening the detection and punishment of illegal short sale activities
Although the organizational capacity to investigate illegal short selling activities has been enhanced and the severity of penalties strengthened, naked short sale activities take place in a routine way, requiring stronger measures to root out illegal short sale activities.
Therefore, a special investigation unit launched at the FSS will carry out a thorough inspection on major global investment banks and impose strict penalties upon finding any illegal activities. Diverse sanctions mechanisms will be employed on rule-breakers, such as a maximum 10-year ban on securities transactions and a restriction from serving as an executive at a listed company or a financial company. Currently, multiple bills on strengthening punishment of illegal short selling are pending at the National Assembly for further parliamentary discussions and review.
Expanding short sale disclosure
Currently, investors whose net short position is 0.5 percent or more of the total issued shares are required to make public disclosure (T+2), and the Korea Exchange (KRX) provides statistics of short sale transactions on a daily and item-by-item basis. However, there are discrepancies between the current disclosure and reporting requirements, which make it difficult for all the short positions from being fully disclosed. Also, the discrepancies have been the source of procedural inconveniences as reporting and disclosure have to take place separately. Moreover, under the current system, detailed statistics about short sale transactions by those exempted from the short selling ban (market makers and liquidity providers) are not provided, making it difficult to accurately identify the current state of investors.
To address this problem, the threshold for disclosure requirement will be strengthened to the level of that for reporting requirement, which is 0.01 percent or more of the total issued shares, or KRW1 billion or more. The KRX will provide detailed information on short sale transactions specified by the type of institutional investors including market makers and liquidity providers.
Expectation and Further Plan
The authorities expect that these proposals will help to bring about improvements to the short selling system and boost fairness and efficiency in capital markets. More specifically, the measures are expected to (a) create a level playing field for all investors, (b) require institutional investors to step up efforts to ensure prevention of naked short selling, and (c) strengthen sanctions on illegal short selling activities, while expanding disclosure and enhancing transparency on short selling.
Based on this set of proposals, the authorities will continue to have discussions at the National Assembly and engage with the public to listen to diverse opinions and consider additional measures that may arise in the process.