[War Against Illegal Short Selling]② The Issue Passed to the National Assembly... Calls for Full Resumption of Short Selling Amid Repeated Stock Price Manipulations

National Assembly Political Affairs Committee to Discuss Short Selling System Improvements in November
Complete Digitalization of Naked Short Selling Difficult
Individual Borrowed Short Selling Repayment Period Extended to 90 Days...Collateral Ratio Reduced from 140% to 120%

"The current securities trading system appears to be one that allows illegal naked short selling. ... (omitted) ... Therefore, it is necessary to improve the securities trading system to fundamentally make naked short selling impossible." "Under the Capital Markets Act, there is no set repayment period for borrowed short selling by institutions and foreigners. Therefore, institutions and foreigners who execute borrowed short selling can wait indefinitely until they make a profit, that is, until the stock price falls, making it structurally impossible to incur losses. It is necessary to limit the repayment period for borrowed short selling to a certain period (e.g., 3 months or 6 months/no extensions allowed)."

- National Assembly Public Petition

The National Assembly's Political Affairs Committee is expected to discuss improvements to the short selling system next month. This is because a public petition calling for the establishment of a short selling electronic system and the limitation of the repayment period for borrowed short selling has gained the support of 50,000 people. When more than 50,000 people agree to a public petition, the agenda is referred to the relevant standing committee.

However, experts believe that discussions in the National Assembly are unlikely to lead to institutional improvements easily. The establishment of an electronic system has already been discussed and concluded, and the repayment period for borrowed short selling is gradually being improved.

On the contrary, some argue that it is time to discuss the full resumption of short selling. This is due to the series of large-scale stock price manipulation incidents that occurred this year. As the price adjustment function for stocks banned from short selling disappeared, there are criticisms that the market is helpless against forces artificially driving up stock prices.

"No Practical Benefit in Electronic System to Prevent Naked Short Selling" Opinion

The public petition regarding short selling system improvements mainly consists of two demands. First, to change the current securities trading system so that naked short selling becomes impossible. The other is to limit the repayment period for borrowed short selling by institutions and foreigners.

Discussions about introducing an electronic system have occurred in the past. It was already discussed during the review of the 2020 Capital Markets Act amendment. At that time, the Financial Services Commission and members of the Political Affairs Committee agreed that there was "no practical benefit" in introducing an electronic system for short selling transactions. The Financial Services Commission judged that it would be difficult to create a perfect electronic system to identify naked short selling, and the lawmakers concluded that the cost-effectiveness was insufficient.

This aligns with what Lee Bok-hyun, Governor of the Financial Supervisory Service, said at this year's Political Affairs Committee audit. On the 17th, when asked about the need for short selling computerization, Governor Lee said, "Personally, I think it would be appropriate for securities firms, which are members of our exchange, to check the stock lending status of clients such as foreign investment banks (IBs) placing short selling orders before executing the orders," adding, "However, how this will be implemented in computerized form requires further consideration by the authorities."

In reality, building a short selling electronic system faces practical difficulties. When a short selling orderer reports the lending balance to a securities firm, the firm submits it to its own system or the Korea Securities Depository (KSD). A KSD official explained, "Each securities firm submits confirmed lending transaction details to the KSD's e-Safe system, but using the KSD system is not mandatory; some securities firms use their own systems, and foreign firms sometimes use other platforms." A Korea Exchange official also said, "The lending balance can only be understood if the trading parties report it. It is not easy to make it impossible in the system from the start, and sanctions cannot be imposed simply because a private lending transaction was not reported."

Another demand of the public petition is the repayment period for borrowed short selling. Foreigners and institutions have no restrictions on the repayment period. There is a reason for this. A KSD official explained, "According to the international standard lending agreement, the lender and borrower mutually agree on the maturity," adding, "The domestic system operates the same way, following the overseas standard of open term (no maturity limit)."

As criticisms that the system is a "tilted playing field" against individual investors continued, the financial authorities improved the system in 2021. The repayment period for individual investors' borrowed short selling was originally 60 days but has now been extended to 90 days. Previously, extensions were not allowed, but now they can be extended without limit. Also, the collateral ratio for individual investors was originally at least 140%, but after the 2021 reform, it was lowered to 120%. For foreigners and institutions, the stock lending collateral ratio is 105%, and for bond lending, it is 102%. Professor Lee Sang-bok of Sogang University Law School said, "If you ask whether the conditions are equal compared to foreigners and institutions, it can still be seen as a 'tilted playing field,' but it is also necessary to consider that the financial authorities are expanding individual investors' access to short selling."

Is Full Resumption of Short Selling Beneficial to the Market?

There are even voices that argue that fully resuming short selling would be beneficial to the market. This is due to large-scale stock price manipulation incidents such as the La Deok-yeon gate in April, the mass limit-down incidents in June, and the limit-downs of Youngpoong Paper and Daeyang Metal in October. A notable characteristic of recent stock price manipulation is that stock prices are gradually driven up over a long period. A Financial Services Commission official said, "Looking at the commonality of stocks involved in price manipulation, they are stocks banned from short selling," adding, "This can be interpreted as meaning that for stocks where short selling is allowed, it is difficult to artificially drive up prices due to price adjustments." This implies that if short selling had been possible, the price adjustment function would have been activated in the market.

Currently, short selling is only allowed for KOSPI 200 and KOSDAQ 150 stocks. When the stock market plunged due to the COVID-19 crisis in 2020, the Financial Services Commission temporarily banned short selling entirely. After the KOSPI surpassed 3000, the resumption of short selling was debated, but due to strong opposition from individual investors, short selling is operated in a limited manner.

Professor Wang Su-bong of Ajou University said, "There are studies showing that foreign investors' short selling stabilizes volatility and contributes to price discovery," adding, "On the contrary, restricting short selling reduces price efficiency and may cause foreign investors to exit, according to research."

Claims that resuming short selling would negatively affect stock prices amid extreme volatility are also less convincing. A Financial Investment Association official said, "No significant relationship has been found between short selling amounts by stock and stock prices," adding, "No significant relationship has been found between the short selling ratio and stock performance (price changes) based on the overall market."