Kim Jung-tae, Deputy Director of FSC, "Domestic Custodian Securities Firms Also Problematic... Strengthening Inspections"
On the 15th, the Financial Supervisory Service (FSS) announced that it had detected for the first time illegal short selling practices habitually conducted by global IBs (investment banks), expressing its intention to expand inspections of domestic securities firms entrusted with short selling. The global IBs caught this time are known to be two companies based in Hong Kong: BNP Paribas and HSBC. They engaged in 'naked short selling,' selling stocks without owning them for a long period and borrowing them afterward. The total amount of illegal short selling is estimated at around 56 billion KRW.
Kim Jeong-tae, Deputy Governor of the FSS, said, "So far, about 10 million individual investors have expressed distrust in the short selling system, and despite the issue being significant in the stock market, large global IBs have continued such practices." He emphasized, "We will expand investigations to other IBs and eradicate illegal short selling behaviors in our market." He added, "We also found that domestic securities firms entrusted with short selling have problems in this case and will take measures accordingly."
The following is a Q&A with Kim Jeong-tae, Deputy Governor of the FSS, and Lee Seung-woo, Director of the Investigation Division 2.
◆ What is the significance of this illegal short selling detection?
▲ Previously detected illegal short selling mostly occurred when hedge funds placed orders. Most cases were due to simple mistakes or errors. This is the first time that global IBs, which provide PBS (Prime Brokerage Service) rather than being end clients like hedge funds, have been found to have maintained such practices over a long period and across many stocks. One of the biggest distrust factors among the approximately 10 million Donghak ants (retail investors) in our capital market has been illegal short selling by foreign investors. Global IBs must have clearly understood Korea's short selling system but deliberately continued these practices.
◆ Which companies are involved, what were the targeted stocks, and what is the expected amount of fines?
▲ The final sanctions will be decided through the Capital Market Investigation Deliberation Committee of the Financial Services Commission and the Securities and Futures Commission. It is not appropriate to disclose company names at this stage. Among the two companies, Company A had the largest illegal short selling volume in Kakao, and Company B had the largest in Hotel Shilla. The largest fine for illegal short selling so far was 3.8 billion KRW, but this fine will be higher. Since fines are often reduced at the deliberation and Securities and Futures Commission stages, it is difficult to state the amount definitively.
◆ Did the illegal short selling affect the stock market at the time?
▲ Since the short selling proportion of individual stocks was not large, it is difficult to definitively conclude that it caused stock price declines. Some stocks fell after their short selling, while others rose. They also incurred losses during the process of short selling and subsequent liquidation.
◆ Was the short selling based on adverse information?
▲ It was not based on adverse information. IBs execute institutional investors' orders and place short selling orders for hedging (risk avoidance). This can be seen as a long-standing neglected illegal short selling practice.
◆ How did the global IBs respond?
▲ They have admitted the allegations. After the FSS detection, Company B improved its system to allow short selling orders only up to the quantity confirmed as borrowed, by entering into sell swap contracts based on the borrowed quantity.
◆ Why did they engage in illegal short selling for such a long time?
▲ They might have thought they would not be detected. We conducted a lengthy investigation for this detection, and generally, it is very difficult to uncover illegal short selling. IBs only act as intermediaries, and profits or losses from stock price fluctuations belong to the final investors. It is presumed they engaged in illegal short selling to earn commission income.
◆ Will investigations be expanded to other companies?
▲ Since this does not seem to be an issue limited to one or two companies, we plan to expand investigations to other IBs to eradicate illegal short selling practices in our market. We will also strengthen inspections of domestic securities firms entrusted with short selling. Domestic securities firms may overlook their clients' illegal acts due to affiliate relationships or commission income interests. We will thoroughly examine the short selling order entrustment process and the possibility of recognizing illegal short selling orders, and take strict action if violations are found.
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