[Inside Chodong] Short Selling Computerized System Put to the Test

Short Selling to Resume at the End of March
Financial Authorities Advance System Improvements and Computerized Measures
Korea Exchange Completes NSDS Development and Begins Integration Testing with Institutions
System Stabilization and Effectiveness Must Be Proven

The long-standing issue in the capital market, which had been quiet for a while, is gradually resurfacing. It is short selling. As the financial authorities are actively preparing ahead of the resumption of short selling in March, interest is growing again.

The short selling issue, which had stirred the capital market, was completely banned in November 2023 and had been dormant for some time. When short selling resumes on March 31, it will be revived after about 17 months. Previously, the financial authorities imposed a full ban on short selling in November 2023 following the detection of large-scale naked short selling by global investment banks (IBs). The ban, initially set to last until June last year, was extended until the end of March this year.

Short selling has always been a "hot potato" in the stock market. Short selling means "selling what you do not have." It is an investment technique where investors borrow stocks they do not own, sell them anticipating a price drop, and then buy them back at a lower price to repay the loan, thereby making a profit. It is mainly used by foreign investors and institutional investors who have information and financial power. Since profits are made only when stock prices fall, individual investors have pointed to short selling as a major cause of stock price declines and have demanded its abolition. Additionally, unlike individual investors, institutional investors have no restrictions on the repayment period for securities lending transactions, leading to ongoing criticism that the playing field is "tilted." Short selling has been completely banned during emergencies such as the 2008 global financial crisis, the 2011 European debt crisis, and the 2020 COVID-19 pandemic, but each time it resumed, it faced backlash from individual investors.

Due to the continuous controversy surrounding short selling, the financial authorities have prepared various regulatory measures ahead of its resumption. They have built a computerized system to prevent naked short selling, unified the trading conditions for short selling between institutions and individuals to address the "tilted playing field," and strengthened punishments and sanctions for illegal short selling, among other institutional improvements.

In particular, there is great interest in the computerized system to prevent short selling. Individual investors have long emphasized the need to establish a real-time computerized system to detect illegal short selling by institutions and foreigners. The Korea Exchange has completed the development of the Short Selling Central Monitoring System (NSDS), which can continuously monitor short selling transactions by institutional investors to prevent illegal short selling, and began linkage testing with major institutional investors who have established balance management systems from the 6th of this month. The Exchange completed system development and internal testing over six months starting in July last year. About 30 domestic and foreign institutional investors, accounting for more than 90% of short selling transactions, are participating in this linkage test, which will check interface connections with the NSDS and data consistency until next month.

The Exchange plans to operate a simulated market from March for institutional investors who complete the linkage test, focusing on system stabilization before the resumption of short selling. To realize the computerized short selling measures, the Financial Supervisory Service issued registration numbers to large-scale short selling corporations starting from the 7th of this month. Corporations with short selling balances of 0.01% or more or 1 billion KRW or more are subject to this. The short selling registration number issuance system is linked with the NSDS, which aggregates all orders by registration number from investors who have received short selling registration numbers and collects transaction information to continuously detect naked short selling.

The capital market is expected to undergo another round of turmoil with the resumption of short selling because individual investors still do not welcome it. Especially, since doubts have been continuously raised about whether illegal short selling can be detected and blocked in real time, stabilizing the system and proving its effectiveness are more important than anything else.