Illegal Short Selling and Activation Support Measures Are 'Half-Hearted'... Ultimately Holding Back Retail Investors

Financial Services Commission's Major System Faces Limits in Boosting Individual Short Selling Participation
KSD's Securities Lending Contract Confirmation System Excludes Foreign Short Sellers Due to Certification Differences
Hankook Investment "Resume Only After Establishing a System That Can 100% Control Illegal Short Selling"

The Korea Stock Investment Association (KOSIA), a private investors' group, will operate buses displaying slogans such as "Abolish Short Selling" and "Dissolve the Financial Services Commission" around Yeouido and Gwanghwamun in Seoul until March 5 to campaign against short selling.
[Image source=Yonhap News]

[Asia Economy Reporter Lee Seon-ae] The support measures being promoted by financial authorities and related organizations to activate individual investors' participation in short selling and to dispel distrust appear to be only 'half measures,' making controversy over their effectiveness inevitable.

According to the financial investment industry on the 10th, the Financial Services Commission is pushing forward the establishment of a lending system to activate individual short selling participation. By building a centralized system, they plan to expand the lending volume to about 1.4 trillion won and additionally secure 2 to 3 trillion won by borrowing stocks held by securities companies and insurance companies.

The problem is that the lending market is based on individual consent, and the consent rate was only 30% as of last year. The market size also shows a huge gap: as of 2019, securities lending amounted to 67 trillion won, while stock lending was only 23 billion won, a difference of more than 2,900 times. There is a strong view that it is practically limited to lead individual short selling participation through the lending system. Moreover, on the bulletin board of the Korea Stock Investors Association (HanTuYeon), an online community with about 40,000 members, posts encouraging participation along with instructions on how to cancel stock lending continue to be posted, sparking a movement to cancel stock lending. An individual investor from HanTuYeon pointed out, "If individual stock lending cancellations continue to increase, the lending system will not function properly," adding, "It is difficult to lead individual participation with this support measure alone."

The Korea Securities Depository's securities lending transaction contract confirmation system, designed to block illegal naked short selling, is also being criticized as an empty shell. The securities lending transaction contract confirmation system refers to the computerized recording and storage method of securities lending transaction contracts, which were previously handled manually between participants, through the Depository's system. Its purpose is to enhance transparency and dispel distrust by storing securities lending transaction information, including the contract confirmation date and time. The problem is that while it will be introduced for domestic investors from March 8, foreign investors will adopt a different authentication method and the system will be introduced within the year. An individual investor from HanTuYeon criticized, "Short selling will resume with foreign investors, who are the illegal short selling forces, excluded, so it is questionable what effect the securities lending transaction contract confirmation system can have."

Currently, most short selling transactions are concentrated in foreign institutions. In January this year alone, foreign investors accounted for 60.26% of the total short selling shares executed. Furthermore, among 32 sanctions imposed for illegal short selling from 2017 to September 2020, 31 cases (96.8%) involved foreign financial companies and pension funds. HanTuYeon argues, "Short selling should only resume after establishing a system that can 100% control illegal short selling," while Hana Financial Research Institute emphasizes, "There is a need for systems and strong supplementary measures to eradicate illegal activities."

Meanwhile, regarding the resumption of short selling only for the components of KOSPI 200 and KOSDAQ 150 from May 3, the industry generally views this as virtually equivalent to full permission, which will dampen individual investors' investment sentiment. The basis is that KOSPI 200 and KOSDAQ 150, which are subject to short selling resumption, hold significant proportions in the market. Kang Dae-seok, a researcher at Eugene Investment & Securities, explained, "(As of the 5th) the KOSPI 200 accounts for 92% of the KOSPI market capitalization, and the KOSDAQ 150 accounts for 48% of the KOSDAQ market capitalization," adding, "In particular, the lending balance ratio of KOSPI 200 is 94% of the total lending balance, and for KOSDAQ 150, it reaches 77%."

The lending balance refers to the volume of stocks borrowed by investors but not yet returned, and generally, an increase in lending balance indicates a higher potential for short selling. Researcher Kang diagnosed, "Looking at the lending balance ratios of major KOSPI and KOSDAQ indices, the partial resumption of short selling will inevitably result in an effect similar to a full lifting of the short selling ban," and predicted, "Since this is disadvantageous to individual investors, it may act as a factor that dampens investment sentiment."