[Inside Chodong] "Tilted Playing Field" Short Selling

"Is it reasonable that even if caught committing illegal short selling, related laws are so lax that no civil or criminal responsibility is imposed?"

"The short selling system only fattens the pockets of foreigners and institutional investors, while the damage falls on individual investors. Short selling must be abolished."

[Asia Economy Reporter Ko Hyung-kwang] These are some of the opinions recently posted on the Blue House's national petition site. In March, the financial authorities, after much deliberation, took the measure of banning short selling for six months in response to panic selling triggered by the novel coronavirus disease (COVID-19). However, petitions demanding the abolition or reform of short selling continue to flood the Blue House's petition site, reaching around 700 submissions.

The reason individual investors are demanding a major overhaul of short selling despite the ban is that fundamental problems remain unresolved. In the stock market, short selling is a kind of necessary evil. Short selling is an investment technique where investors borrow shares of stocks expected to decline in price, sell them, and then buy them back at a lower price to return the shares and earn a profit. It serves a positive function by curbing excessive price surges during overheated markets to prevent bubbles and by supplying liquidity during downturns.

However, there are chronic drawbacks to this positive function. First, short selling is a system somewhat detached from individual investors to the extent that it is almost exclusively the domain of foreigners and institutional investors. Until the announcement of the short selling ban by the Financial Services Commission on March 13 this year, the total short selling transaction amount in the stock market (KOSPI + KOSDAQ) reached 32.7082 trillion won. Of this, foreigners accounted for 55.1% (18.0183 trillion won), institutions 43.7% (14.3 trillion won), and combined, these 'big players' made up 98.8% (32.3183 trillion won). Individual investors' short selling accounted for only 1.2% (3.892 billion won).

This is because, although short selling is allowed for individual investors, the procedures are complicated, and the borrowing period is limited differently from foreigners or institutions, resulting in significantly lower accessibility to short selling. Additionally, individuals generally have weaker creditworthiness and repayment ability compared to big players, which also hinders their short selling activities. Ultimately, short selling is out of reach for individual investors. This is why the system is criticized as a 'tilted playing field.'

Another problem is the weak punishment for illegal short selling. 'Borrowed short selling,' where investors post collateral and borrow shares to sell, is permitted, but 'naked short selling,' where shares are sold first without borrowing, is illegal. According to the Financial Supervisory Service, over the past 10 years, 101 financial companies have been sanctioned for illegal short selling in the domestic stock market, but the sanctions were limited to fines (45 companies) and warnings (56 companies).

Under the current Capital Markets Act, there is no penalty other than fines for violating the short selling ban. This contrasts sharply with the United States, which imposes heavy penalties for illegal short selling, including fines up to 5 million dollars (about 6 billion won) or imprisonment for up to 20 years. Because penalties for illegal short selling are so lenient, the practice persists annually, only deepening investors' distrust.

The financial authorities are somewhat aware of the problems with the current short selling system. On the 11th, at a press briefing on the financial policy direction for the second half of the year, Financial Services Commission Chairman Eun Sung-soo stated, "Even if short selling transactions resume, it will not be immediate; we will consider improvements to the system, restoration, and communication with the market to see if an extension is necessary," reflecting this awareness.

The controversy over short selling is not new. Each time, the financial authorities have pledged to "work on system improvements to reduce side effects." However, these have been mere words. The foundation of the stock market is mutual trust. It is urgent to properly reform short selling this time to restore market trust. This is also a golden opportunity for the financial authorities to signal to the market that they are fair arbiters. Correcting the tilted playing field depends on the authorities' will.

This content was produced with the assistance of AI translation services.