South Korea continues crackdown on short selling

A screen displays prices of crypto currencies inside Upbit Lounge in Seoul, South Korea, on Monday, May 20, 2024. Upbit, the South Korean exchange operated by Dunamu Inc., now accounts for almost 5% of overall crypto trading volume globally, up from 1.4% in January 2021, according to CCData. Photographer: SeongJoon Cho/Bloomberg

SEOUL: Since November, South Korea has intensified its crackdown on illegal short selling by institutional investors, uncovering widespread practices among global banks.

In an interim results announcement earlier this month, the Financial Supervisory Service (FSS) revealed that all nine banks investigated had engaged in illegal short selling totaling approximately 211.12 billion won in South Korean stocks.

With ongoing investigations into the five remaining foreign banks, this figure is expected to rise.

This disclosure has prompted a further outcry from retail investors, who have been calling for stricter regulations on naked short selling. Defined as illegal under South Korea’s Capital Markets Act, naked short selling involves shorting stocks without first borrowing or securing the availability for borrowing.

While recognising the need for regulatory improvement, authorities noted that these revelations partly stem from the country’s stricter regulation of naked short selling compared with other jurisdictions, rather than solely from malicious intent by institutions.

“We don’t perceive global banks as particularly dismissive of South Korea,” FSS senior deputy governor Hahm Yong-il stated during a brief about the investigation results.

“We are aware that large-scale illegal short selling hasn’t been reported elsewhere, suggesting either South Korea enforces stricter regulations, or investment banks limit such activities to South Korea. But, other countries haven’t conducted such extensive and specific probes into short selling. If they did, I believe the outcomes would be similar,” he added.

Hahm’s remarks align with the FSS’ findings that most naked short selling cases stem from inadequate balance management systems, rather than unfair trading practices. While sanctioning unlawful behaviours is essential, authorities emphasise the necessity for systematic improvement to effectively manage short selling.

In response, the regulatory body is developing a computerised system to curb illegal short selling. Last month, the FSS introduced the “Naked Short Selling Detection System,” automating institutional investors’ stock balance management to filter out sell orders that surpass their holdings and prevent unintended naked short selling.

Although the introduction of such a system appears promising, analysts have voiced their concerns about excessive burden and control, not only regarding naked short selling but all short selling, until enhancements are fully implemented in the real market.

“What the authorities are asking institutions to do is establish a new system tailored specifically for the South Korean market. This involves significant financial investment, which raises entry barriers,” Kang Kyeong-hoon, a business professor at Dongguk University, told The Korea Herald.

Kang also raised doubts about the system’s effectiveness, highlighting its reliance on the voluntary participation of institutions. The upcoming two-step process involves institutions initially managing short selling balance and transaction records autonomously, followed by centralised monitoring of unfiltered naked short selling by authorities.

Forcing their involvement would only further distance South Korea from the global standard, he warned.

However, despite such apprehensions, the FSS aims to mandate the system through legislation. To make the monitoring system effective, the Capital Market Act needs revision to legally compel institutional investors to disclose their short selling balance information to external entities.

“This implies a pre-screening system. Not only does this incur additional costs for institutions, but it’s unprecedented in other countries. Established market participants may comply reluctantly, but it will pose a significant hurdle for newcomers,” noted Hwang Sei-woon, a senior fellow researcher at the Korea Capital Market Institute.

Even if the amendment successfully passes at the parliamentary level, establishing the computerised system is anticipated to take at least a year.

This implies that the current short selling ban, scheduled to be lifted in July, appears poised for an extension.

Market watchers project the ban will likely persist at least throughout this year, until when the FSS aims to wrap up its global banks investigation. — The Korea Herald/ANN

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