Improving Short Selling: Where Should We Start?

Market Makers Consider Narrowing Short Selling Scope... Also Pushing for Harsher Penalties

[Asia Economy Reporter Park Jihwan] As financial authorities recently decided to extend the short selling ban by six months and announced plans to improve the system, attention is focused on where to start reforming the current short selling regulations. The market expects that priority measures will include reducing the scope of short selling by market makers (securities firms), revitalizing stock lending services for individual investors, and strengthening penalties for illegal short selling.

According to financial authorities on the 31st, the Financial Services Commission has decided to extend the short selling ban until March 15 next year, considering the resurgence of COVID-19, and plans to complete system improvements before resuming short selling. The overall framework has been set. Complete abolition of the short selling system, which has been raised mainly by individual investors, will not be considered. This is due to the positive functions such as removing overheated stock price bubbles and supplying liquidity to the stock market.

The financial authorities are currently discussing conducting an inspection of the Korea Exchange, which operates the market maker system, within this year. Market makers are entities that contract with the Korea Exchange and simultaneously provide both buy and sell quotes to facilitate smooth trading in stocks that require liquidity.

Market makers are exempt from the short selling ban. Currently, 12 firms including Mirae Asset Daewoo, Shinhan Financial Investment, and Goldman Sachs are engaged in market making. They submit buy quotes for stock futures and, when executed, hedge by selling the same quantity of the underlying stocks, thereby utilizing short selling.

Individual investors have criticized market makers for being able to short sell even banned stocks at any time and for not being subject to the uptick rule (a regulation that restricts short selling to prices above the last traded price), raising concerns about potential market manipulation. The Financial Services Commission is reviewing system improvements to reduce the scope of short selling by market makers for certain stocks where market making is unnecessary.

Measures to strengthen sanctions and penalties against illegal naked short selling will also be actively pursued. Currently, only fines are imposed, which is considered insufficient given the severity of the misconduct, making it difficult to deter criminal intent. Among 101 cases of naked short selling detected from 2010 to the end of last year, 45 were fined and 56 received warnings. Except for the fine of 7.548 billion KRW imposed on Goldman Sachs International in November 2018, the total fines imposed on 44 financial firms amounted to only about 1 billion KRW, indicating weak penalty levels.

Plans to activate individual short selling from the perspective of expanding opportunities are also being explored. Last year, individual investors accounted for only 1.1% of the 103.4936 trillion KRW short selling transaction volume in the domestic stock market. Foreigners (62.8%) and institutions (36.1%) accounted for a total of 98.9%.

The Financial Services Commission plans to create an environment that enhances individual investors' accessibility to short selling by revitalizing securities firms' stock lending services for individual investors in the second half of this year.

Short selling is an investment method that involves borrowing stocks not actually owned and selling them at the current price, but in Korea, it is difficult for individuals, who have lower creditworthiness compared to foreigners or institutional investors, to borrow stocks. A Financial Services Commission official explained, "We plan to take a cautious approach to increase stock lending accessibility for individual investors," adding, "Considering recent losses seen in some private equity funds, we are also reviewing investor protection measures to anticipate potential criticism about why the path was opened in the first place."

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