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[Asia Economy Reporter Ji Yeon-jin] Since the Financial Services Commission resumed short selling on the 3rd of last month, the systems put in place to prevent naked short selling appear to have failed to function properly.

According to the results of the illegal short selling information disclosure request released by the Citizens' Coalition for Economic Justice (CCEJ) on the 7th, the Korea Securities Depository established a ‘Securities Lending Contract Confirmation System,’ but in the case of foreigners, naked short selling can only be confirmed two days after the settlement instruction. This is because, in addition to borrowed short selling, the ‘sale of non-owned stocks’ is allowed.

◆ Inspection method allows intentional violations = Short selling is a trading transaction where institutions holding stocks, such as securities firms, lend stocks through securities lending contracts and sell them, then buy back the stocks in a declining market and return the borrowed quantity. However, it is permitted to pre-sell listed securities with repurchase contracts within the contract quantity on the settlement date (T+2) for cash settlement, or to pre-sell convertible bonds (CB), exchangeable bonds (EB), and bonds with warrants (BW) related to rights such as paid or unpaid capital increases and dividends, and then receive or exchange them for listed stocks on the listing date for settlement. Because of this, if stocks are sold in the morning and bought back in the afternoon in the same quantity, transactions without securities lending contracts are difficult to detect as illegal short selling as long as the quantities match.

On the 7th, officials from the Citizens' Coalition for Economic Justice in Jongno-gu, Seoul, held a press conference urging the Financial Services Commission to disclose information on illegal short selling and calling for improvements to the short selling system and regulations. Photo by Kang Jin-hyung aymsdream@

Moreover, since this system is a post-inspection method, voluntary manual contracts, manual input, and manual stock receipt continue to be allowed, making it difficult to expect effectiveness. The CCEJ pointed out, "Even if there are voluntary internal control measures, foreigners can ‘intentionally violate’ at any time if they wish," and added, "The system relies only on voluntary short selling position reports and disclosure obligations by operators, and there are no punitive surcharges or fines to fundamentally block illegal profits or incentives." In fact, according to the Financial Services Commission’s recent evaluation one month after the resumption of short selling, the Korea Exchange is currently auditing about 120 unsettled securities lending transactions and 600 suspicious ‘pre-sell-post-buy’ transactions of non-owned stocks.

According to the Financial Supervisory Service’s report on types of illegal short selling by foreign investors released this year, most cases involved selling non-owned listed stocks. This method involves selling stocks by mistakenly ordering sales without reflecting the sold stocks in the balance, even though the stocks were not actually held. The CCEJ criticized that institutional and foreign investors’ manual stock trading practices have not been properly addressed through system improvements.

Furthermore, when securities lending transactions are conducted to secure short selling quantities, lenders such as securities firms can lend not only their own stocks but also stocks entrusted by third parties (clients) or stocks held through consignment trading to short selling investors. In this process, loopholes have been found. Lenders can lend securities lending stocks indefinitely and without limit by repeatedly lending the same stocks to different borrowers. A bigger problem is that when the Korea Exchange aggregates securities lending balances, it may sum up all quantities from the initial securities lending transaction, including overlapping lending quantities, re-lending, and re-re-re-lending, rather than the actual securities lending balance quantity. The CCEJ emphasized, "To effectively prevent illegal short selling in the securities settlement system, not only the borrowing status of physical stocks before short selling transactions but also the actual holding status must be pre-verified through balance management."

◆ Ban short selling of shares held by major shareholders including the National Pension Service = They also urged a ban on short selling transactions and lending of stocks and convertible bonds held by major shareholders with more than 5% ownership, including the National Pension Service. In Japan and the Netherlands, public pensions are prohibited from lending stocks for short selling purposes. This is because unfair speculative gains between short selling investors (capital-free M&A speculative forces) and major shareholders can cause damage to investors and minority shareholders.

Meanwhile, the CCEJ requested information disclosure related to illegal short selling investors and affected stocks from the Financial Services Commission in March this year, following a similar request in 2019, but the Financial Services Commission only disclosed partial information excluding financial companies caught for illegal short selling. The CCEJ urged, "Is naked short selling really a legitimate business secret?" and called for disclosure of violators and affected stocks to protect shareholder rights and national assets from illegal short selling.

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