FSC Chairman Kim Joo-hyun presided over a joint meeting with relevant institutions on July 28 and announced the measures to improve the stock short selling system and strengthen oversight and punishment on illegal short selling activities. At the meeting, participants shared the same view that investors’ growing concerns about the use of short selling in illegal transactions and the ineffective oversight and punishment on illegal short sale activities need to be resolved in order to restore investors’ trust in domestic stock markets. In this regard, through joint efforts, authorities agreed to strengthen oversight, detection and punishment of illegal short selling activities and promptly pursue improvements to the short selling system to stamp out illegal short selling activities.
Overview of the Meeting
A joint meeting to stamp out illegal short selling activities was held on July 28 chaired by FSC Chairman Kim Joo-hyun. As investors’ mistrust toward the short selling system continues to grow with recent declines in global stock markets, the meeting was held as the authorities deemed it necessary to (a) promptly address the need to bolster oversight and punishment over market disturbing activities in capital markets through illegal short selling activities and short selling-based price rigging and (b) discuss and announce the measures for bringing about prompt improvements to the short selling system to help address the issues raised by investors.
Background
Short selling involves a sale of borrowed stocks. As an investment strategy aimed at gaining profits or avoiding losses when stock prices fall, it is an investment method generally allowed in markets across all advanced economies. Short selling helps to increase market liquidity and prevent formation of bubble in stock prices. However, in the wake of the COVID-19 crisis in March 2020, a short selling ban was introduced to help ease market anxieties.
Since the introduction of short selling ban, various improvements have been made on the stock short selling system as shown below.
a) Punishment for illegal short selling activities has been strengthened from a fine to a greater level of monetary sanction as well as imposition of a criminal penalty.
b) The oversight and detection system for institutional and foreign investors’ illegal short selling activities has been strengthened.
c) Short selling opportunities for individual investors have been expanded through an upgrade to the stock lending system for individual investors.
d) The volume of short selling by market makers has been reduced by more than a half through regulations on market markers.
⇒ In May 2021, a partial resumption of short selling took effect on KOSPI 200 and KOSDAQ 150 shares.
Despite these measures, there have been calls for making further improvements to the short selling system. There are continuing doubts about whether illegal short selling activities are being detected effectively. There also have been complaints that the short selling conditions for individual investors are unfavorable vis-à-vis institutional and foreign investors.
⇒ Therefore, the authorities have made a reassessment on the short selling system and prepared a plan to make improvements.
Details of the Plan
I. Strengthen Oversight and Punishment on Illegal Short Selling Activities
Authorities will seek stronger oversight and detection while imposing strict punishment at the same time.
a) Strengthen targeted investigation on unfair transactions linked to short selling
- Set the theme for investigation targeting stock items after closely selecting the area where the probability of using illegal short selling is high through analyzing trends in stock prices, short selling proportion, etc.
- Carry out targeted investigation immediately upon finding charges for engaging in illegal activities
b) Pursue prompt investigation on naked short selling activities
- Have planned inspection on short selling regularly and promptly carry out investigation on suspicious cases
- Review the appropriateness of the process of placing short sale orders at securities firms (including foreign securities firms) and check for naked short selling violations
c) Carry out strict investigation and punishment
- Set up a real-time monitoring sharing system between the KRX’s market monitoring committee and the FSS’s illegal short selling monitoring data for detecting illegal activities in a timely manner and pursue prompt investigation
- Make use of the fast-track investigation process centered around the joint investigation unit set up at Seoul Southern District Prosecutor’s Office to impose strict punishment (imposing high levels of fines for corporate entities) that is commensurate with the severity of the crime when the level of damage is severe and seek forfeiture of illegal profits and concealed properties gained through illegal short selling
d) Set up and expand illegal short sale investigation teams
- Enhance organizational capacity at the Korea Exchange and Financial Supervisory Service to strengthen detection of illegal short selling activities
- Make qualitative improvements to investigating illegal short sale activities and operate a response system that allows an immediate investigation and punishment of illegal short selling activities
II. Strengthen Monitoring over Stock Lending Transactions
Authorities will prepare a close monitoring system on stock lending transactions which will be used to inspect illegal short selling activities.
a) Introduce an obligation to report to the financial authorities 90 days after stock lending takes place for short selling purpose (revision to the regulation on financial investment business required)
b) Require to have stock lending information (stock lending balance at opening and closing) included when filing a report for large-scale short positions (revision to the regulation on financial investment business required)
III. Expand the Application of Overheated Short Selling Stock Designation
Authorities will bolster the application of the overheated short selling stock designation system by introducing new criteria for designating overheated short selling stock items (revision to the operating rules of the Korea Exchange required).
a) Designate a stock item as an overheated short selling stock item when the proportion of short orders is 30 percent or more even when the price drop (3% or more) and the increase in the amount of short selling transactions (twice or more) remain low
b) Automatically extend and carry over the application of short selling ban until next day when stock prices decline 5 percent or more while short selling ban is in place (ongoing)
IV. Provide Retail Investors with Fair Opportunities for Short Selling
Authorities will work to provide fair opportunities to individual investors by lowering margin requirement (collateral ratio), etc.
a) Lower individual investors’ margin requirement (collateral ratio) from 140 percent currently to 120 percent (revision to the regulation of financial investment business required)
- Taking into account comprehensive factors such as the soundness management of securities firms, individual credit risk and overseas cases (e.g. 120% in Japan) where individual stock lending and borrowing takes place regularly
b) Stock lending and borrowing with no restrictions of repayment period already available for professional investors (including individual investors) → Promote stock lending transactions for professional investors through securities firms
Further Plan
In order to help improve public trust on the short selling system, authorities will promptly implement the specific measures. In particular, the measures to strengthen oversight and punishment on illegal short selling will be implemented as soon as possible while the measures requiring revision to existing regulations will be carried out with a goal to begin implementation within this year.
* Please refer to the attached PDF for details