The Financial Services Commission convened an extraordinary session on March 21 and decided to fully reinstate stock short selling as previously planned from March 31. The decision has been reached as the financial authorities determined that concerns over factors undermining fair price formation in the market can be resolved with the short sale reform measures put in place thus far. To help ease the impact of reinstating short selling on certain stock items, the designation scheme for overheated short selling stocks—which restricts the short sale in the following day of individual stock items that have been subject to rapid increases in short sale orders in the previous day—will be operated in an expanded capacity until May 31, 2025. The complete resumption of short selling, which will take place for the first time in about five years with a newly established computerized system, is expected to help enhance the external credibility and market efficiency of Korea’s stock markets.
Key Details and Progress of Short Sale Reform Measures
(a) From Monday, March 31, 2025, short selling becomes available for institutional investors that have set up required computer systems intended to prevent naked short selling (or those placing short sale orders after entering borrowed stocks into their accounts). Institutional and corporate investors can engage in short selling only if they have established relevant internal control standards. In addition, securities companies are obligated to submit short sale orders only after verifying the establishment of required computer systems and internal control standards by institutional and corporate investors.
The naked short selling detecting system (NSDS) has been established at the Korea Exchange (KRX) and has been running simulations this month after conducting linked tests with institutional investors’ own computer systems from January to February. At the time of this release, 21 institutional investors (the number is tentative) that made up about 81 percent of all short sale transactions prior to the initiation of the short sale ban on November 3, 2023 are participating in the simulation. Thus far, the simulation outcome shows that violation detection mechanisms are functioning properly. 62 institutional investors (the number is tentative)—which accounted for about 4.6 percent of all short sale transactions before the ban was initiated—have chosen the method of engaging in short selling by submitting short sale orders after entering borrowed stocks into their accounts, thereby removing the potential of naked short selling activities (all other institutional investors will resume short selling after developing required computer systems). Therefore, at the time of this release, a total of 83 institutional investors that made up 85.6 percent of all short sale transactions prior to the initiation of the ban have established required mechanisms designed to prevent naked short selling and will be able to resume short selling from March 31.
(b) From March 31, the stock borrowing conditions for short sellers will be made identical for both institutional and retail investors.
Institutional investors’ stock repayment period will be limited to 90 days and renewable for maximum 12 months. With the completion of required system modification at the Korea Securities Depository and the Korea Securities Finance Corporation, since November last year, this new rule on repayment period has been already put in place for market makers and liquidity providers that have been exempted from the short sale ban. When short selling becomes reinstated on March 31, this new rule on stock repayment period will apply to all securities lending intended for short selling.
Retail investors’ cash collateral ratio will be lowered to 105 percent, the same level currently in place for institutional investors. The restriction on repayment period—90 days and renewable for maximum 12 months—will also be equally applied to retail investors. As of now, 28 securities companies have made modifications to their systems to accommodate the change in retail investors’ cash collateral ratio, and this will take effect from March 31 along with the restriction on repayment period.
(c) Naked short sale activities carried out in a deliberate manner after the resumption of short selling on March 31 will be subject to enhanced criminal penalties. Other rule changes regarding the acquisition of convertible bonds (CBs) and bonds with warrants (BWs) by short sellers will also go into effect as previously planned.
First, the monetary penalty imposable on naked short sale activities carried out in an deliberate manner will increase to four to six times the amount of unfairly gained profits from the previous level of three to five times the amount of unfairly gained profits. If unfairly gained profits amount to KRW5 billion or more, an aggregated punishment of imprisonment can be imposed. In addition, as in the case with the currently existing rule on the acquisition of new shares in capital increase with consideration, short sellers will be prohibited from acquiring CBs and BWs issued by the same company from the time the company discloses its CB or BW issuance plan until the time it discloses its issue price. The disclosure requirement on investor’s net short position balance has been expanded since December 2024, and as a result, investors with a net short position balance of 0.01 percent or KRW1 billion or more of total issuance volume are already subject to the disclosure duty. In the meantime, the diversified sanctions mechanisms brought against those committing naked short sale or unfair trading activities—which include measures prohibiting them from trading financial investment products, barring them from holding an executive position at companies, and freezing account activities—are set to go into effect from April 23, 2025.
Reinstating Short Selling
With the short sale reform measures and relevant policy efforts put in place thus far, it is expected that prevalent concern about short selling undermining market’s fair pricing function can be resolved to a large extent. Once the improved rules take effect on March 31, a completely computerized short selling system will begin to operate on all listed stocks, which will ensure the establishment of preventive mechanisms against naked short selling. After carrying out inspections on global investment banks (from September 2024 to March 2025) and distributing a guideline on short selling (in January 2025), the financial authorities found that investors’ misunderstanding about short selling has been resolved and the inappropriate short sale practices taking place in a routinized manner have been rectified. Thus, short selling will be reinstated as scheduled from March 31.
However, as there are concerns over a possible rise of volatility in certain stock items following the reinstatement of short selling, to help ease this problem, the designation scheme for overheated short selling stocks will be operated in an expanded capacity in stages and for a temporary period of two months until May 31. The designation scheme for overheated short selling stocks restricts short selling in the following day of individual stock items that have been subject to rapid increases in short sale orders. Overheated short selling stock items are designated in accordance with specific criteria, which include (a) the rate of increase in the value of short sale transactions, (b) the rate of fall in stock price, and (c) the proportion of short sale transactions value to total trading value. In this regard, adjustments will be made in stages to certain criteria to allow more room for designating overheated short selling stocks during the first two months. Considering a simulation of monthly average data from 2018-2019 when short selling was available on all stock items, the authorities plan to operate it at about twice the simulated monthly average in April (35.9 times for KOSPI and 112.3 times for KOSDAQ) and at about 1.3 times the simulated monthly average in May (23.8 times for KOSPI and 71.2 times for KOSDAQ).
Further Plan
Until March 31, the day of full resumption, the government and related organizations plan to continue to work on thorough preparations for the full resumption of short selling, which will take place for the first time in about five years, and make every effort to ensure the establishment of effective mechanisms that will help to prevent naked short selling. There will be continuing simulations until March 27 to thoroughly test the effectiveness and stability of computer systems at institutional investors and the central monitoring and inspection system (NSDS). Institutional investors that are deemed to have an inadequate level of system development will be allowed to resume short selling after making required improvements to their systems. Institutional investors setting up their computer systems after April will be able to engage in short selling after going through a system verification process in connection with the NSDS (for two weeks) and through simulation (for two weeks). In addition, the Financial Supervisory Service will conduct a final inspection on whether securities companies have verified the computer systems and internal control established by institutions before short selling resumes. In the meantime, once short selling is reinstated on March 31, the government and related organizations will strengthen monitoring over market activities and enhance market surveillance to ward off unfair trading activities.
* Please refer to the attached PDF for details.