The Financial Services Commission issued a prior notice of legislative changes regarding short sale regulations as a follow-up to the previously revised Financial Investment Services and Capital Markets Act (FSCMA) promulgated on October 22. The rule changes being proposed today address specific details that need to be stipulated under the revised FSCMA, which are expected to take effect from March 31, 2025 as follows—(a) limiting the stock borrowing period for institutional investors, (b) introducing measures to prevent naked short sale through establishment of electronic net short position balance management system, internal control standards, and the securities companies’ verification duties, and (c) restricting short sellers from acquiring CBs (convertible bonds) and BWs (bonds with warrants) issued by the same company.
Imposing a Limit on Institutional Investors’ Stock Repayment Period
The stock repayment period for institutional investors should be determined by an agreement of both the lender and the borrower but should be limited to up to 12 months with 90-day repayment periods for renewal each time. However, exemptions are recognized in the case of delisting of stocks or trading suspension on the day of repayment, or when an account-to-account transfer (for bookkeeping entry at central securities depository) is being restricted. A violation of the repayment period may be subject to an administrative fine of KRW100 million for corporate investors and KRW50 million for retail investors.
Introducing Measures Intended to Prevent Naked Short Sale Activities
Corporate entities with an intention to engage in short sale of listed stocks need to take appropriate steps to prevent naked short sale in accordance with the revised FSCMA.
All corporate entities should prepare internal control standards designed to prevent naked short sale. Their internal control standards should specify the role and responsibility of employees, item-by-item management of net short position balance, and the recording and bookkeeping of short sale transactions details for five years. For institutional investors that are also required to set up their own electronic short sale processing and monitoring systems, their internal control standards should also include the issues regarding the operation of an electronic management system. Financial companies with their own independent trading units need to carry out unit-by-unit balance management according to their own internal control standards, and separate item-by-item balance management is also required for the accounts held by market makers and liquidity providers and for funds and trusts related assets.
Once the revised FSCMA takes effect on March 31, 2025, corporate entities with a net short position balance of 0.01 percent of total issuance volume (excluding net short position balance of less than KRW100 million) or KRW1 billion or more and institutional investors (market makers and liquidity providers) will be required to set up and operate their own electronic net short position balance management systems to facilitate item-by-item short position balance management and prevent naked short sale. In addition, they need to submit item-by-item daily balance data to the Korea Exchange (KRX) within two business days of every business day to facilitate inspections by KRX’s Naked Short Sale Detecting System (NSDS) scheduled to be set up in March next year. Short sellers will be required to register with the FSS and use their registration numbers for trading to allow closer monitoring over naked short sale activities and comparison of the balance data and order transactions by authorities.
However, when borrowed stocks have been entered into the account prior to submitting short sale orders, which poses no risk of naked short sale activities, the obligation to set up and operate an electronic net short position balance management system will be exempted. For corporate entities that are expected to become institutional investors for the first time, they need to notify securities companies and either suspend short sale transactions until an electronic net short position balance management system is established or engage in short sale activities only after entering borrowed stocks into the account.
Securities companies carrying out short sale transactions on behalf of corporate entities will need to check and verify the establishment of internal control standards and electronic short sale processing systems (for institutional investors) once every year and report their verification results to the FSS within one month. Securities companies’ naked short sale prevention measures should be verified and reported to the FSS by independent units that are not involved in short sale activities.
Corporate entities and securities companies found to be in violation of the naked short sale prevention measures can be subject to an administrative fine of up to KRW100 million even when there is no naked short sale activity being involved. For financial investment businesses, such as securities companies, authorities may impose sanctions against the company and its employees. More specific details regarding the internal control standards, electronic short sale processing and monitoring system, and the securities companies’ verification duty will be prescribed in the enforcement rules of the FSS. Details of regulatory changes will be comprehensively provided through the previously introduced guidelines by the FSS.
Restricting Acquisition of CBs and BWs
Short sellers will be prohibited from acquiring CBs and BWs of a company if they engaged in short sale of same company stocks between the time the company disclosed its CB or BW issuance plan (D+1) and the time it announced its issue price. However, same as the previous introduced short sale rule on the acquisition of new shares in capital increase with consideration (introduced in April 2021), an exemption will be applied when the volume of purchased shares exceeds that of short sale orders during the aforementioned period.
Other Regulatory Reform Areas
As an alternative trading system (ATS) is expected to be launched in the first half of 2025, the same display rules currently in place for short sale orders at the KRX will be applied to the ATS.
In addition, the supervisory rules on financial investment businesses have been upgraded to provide more clear standards on short sale by requiring a separate management of accounts held by market makers and liquidity providers and funds and trusts related assets.
Further Plan
The rule changes will enter a comment period until December 31, and the revision will be finalized by March 2025 after going through a legislative review and an approval process by the government. Meanwhile, certain areas of short sale reform measures that require no revision to legislation have already been completed, which include lowering retail investors’ cash collateral ratio for borrowing stocks to 105 percent from 120 percent previously, limiting the stock repayment period for market makers and liquidity providers for their short sale transactions, and strengthening the disclosure requirement on net short position balance from 0.5 percent previously to 0.01 percent or KRW1 billion or more.
In addition, separate from the regulatory changes being proposed today, a prior notice of legislative changes regarding the diversification of sanctions measures on unfair trading and illegal short sale activities, which are scheduled to take effect from April 23, 2025, will be announced within this year.
The FSC and related organizations will work to ensure a seamless implementation of the short sale reform measures and finish up establishing an electronic short sale processing and monitoring system to make sure that short sale trading can resume according to the schedule from the end of March 2025.
* Please refer to the attached PDF for details.