[이코노믹리뷰=정다희 기자] On the 3rd, the Financial Services Commission announced that it had decided to extend the ban on short selling, which was temporarily applied since March last year, until May 3rd. The Financial Services Commission announced that even if short selling is resumed on the day, it is planning to resume partial stocks rather than resuming all stocks at once.
The following is the contents of the Korea Exchange, Korea Securities Depository, Korea Securities Finance, Financial Investment Association, and Koscom to answer 10 questions related to short selling in order to resolve the misunderstanding of short selling.
Q. Short selling causes stock prices to fall, and should short selling be banned in Korea, which has a high proportion of short selling compared to overseas?
A. (Exchange answer) The argument that short selling causes stock prices to decline has not been proven theoretically or empirically until now. There was no significant difference between the period of prohibition of short selling in countries that also banned short selling due to Corona 19 and the rate of increase in stock prices of countries that did not ban in the same period after resumption. Major financially advanced countries such as the United States, the United Kingdom, and Japan did not take a ban on short selling, as they believe that short selling will not cause a decline in share prices even during the stock price plunge due to the Corona 19 crisis. The share of short-selling transactions in Korea’s stock trading is around 4%, which is smaller than that of major countries such as the US (46.7%) and Japan (41.1%) as of last year.
Q. Are short-selling investors gaining excessive profits in the market, and are individual investors suffering damage from this?
A. (Exchange answer) Short-selling investors are not always profiting. Just like regular investors, short selling can also suffer losses. Rather, in theory, the range of losses is infinite, and the risk is greater than the usual buy, where losses are limited to the investment principal. In 2020, short-selling Tesla investors lost $40.1 billion (about 44 trillion won) last year, while short-selling investors from Apple and Amazon posted a loss of $6.7 billion (about 7.400 billion won) and $5.8 billion (6.4 trillion won), respectively. appear.
Q. Is the level of punishment for illegal short selling in Korea weaker than in the US, where you can face up to 20 years in prison?
A. (Exchange answer) Due to the revision of the Capital Markets Act at the end of last year, from April 6th, criminal penalties such as fines within the order amount and imprisonment for more than one year have become possible for those who made illegal short sales. There is a view that the punishment is weak because the law stipulates that imprisonment for a period of at least one year is imprisoned. In the case of penalties, the entire order amount is imposed as a limit regardless of profit or not. Even if the order amount is 10 billion won for illegal short selling, a penalty of up to 10 billion won can be imposed even if it loses.
Q. Is the level of punishment for illegal short selling in Korea weaker than in the US, where you can face up to 20 years in prison?
A. (Exchange answer) Due to the revision of the Capital Markets Act at the end of last year, from April 6th, criminal penalties such as fines within the order amount and imprisonment for more than one year have become possible for those who made illegal short sales. There is a view that the punishment is weak because the law stipulates that imprisonment for a period of at least one year is imprisoned. In the case of penalties, the entire order amount is imposed as a limit regardless of profit or not. Even if the order amount is 10 billion won for illegal short selling, a penalty of up to 10 billion won can be imposed even if it loses.
Q. Even if an investor submits an illegal short sale order, is the brokerage company not obligated to check it, and is it impossible to punish the brokerage company even if it receives an illegal order?
A. (Answers to Gold Tulips) Under the current capital market laws, when an investor submits an order to sell stock to a securities company, the securities company is obligated to confirm whether the selling order is a short sale and whether settlement is possible according to the short sale order. In accordance with the financial investment association’s best practices, prior to consignment of a short sale order, a list of investors’ lenders and other settlement plans are checked. If a brokerage company receives an illegal short sale order, it is currently subject to fines, but according to the Capital Markets Act revised from April 6, the same grounds have been established to impose criminal penalties and fines in the same manner as investors who made illegal short sale.
Q. Is it an illegal short selling attempt to reject a large number of orders in the Foreign Investment Management System (FIMS)?
A. (Coscom answer) The foreign investment management system (hereinafter referred to as FIMS) is a computerized system in operation to comprehensively manage the investment status of foreigners’ listed stocks. In FIMS, in order to strictly manage foreigners’ acquisition limits for national key industries such as the power business, aviation industry, and telecommunications industry, stocks acquired through various transactions are allowed to sell only after they have entered their account. Sell orders for shares that are not in the account are processed as order rejection by the system.
For FIMS limit management stocks, the selling method that allows the sale after entering the account is different from the general selling method. This is an unfamiliar trading method for foreign investors. In general, if it is’planned’ that stocks will be in your account so that payment can be made on the settlement date through various transactions, selling is allowed even before entering the account. For example, stocks that are scheduled to be received from a company through a capital increase or stock dividend can be sold from two days before the scheduled date.
Due to the difference in trading methods, it is very frequent that the transaction price that would have been ordered normally in the general case, and the “order rejection” attempt to sell the “scheduled stock” that will be in the account in the FIMS limit management item is processed. Since this is an attempt to sell stocks that have legitimate rights to sell, it cannot be considered as an attempt to sell without borrowing.
Q. Is the level of disclosure obligations for stocks with excessive short selling and short selling investors weak compared to the global level?
A. (Exchange answer) The argument that Korea has a weaker disclosure obligation related to short selling compared to foreign countries is not true. Rather, the strict disclosure obligation is applied. As the size of short selling by stock is disclosed, general investors can also know the current status of stocks with a large short selling scale.In the case of investors who have sold short for a specific stock at 0.5% or more of the total number of issued shares, personal information such as name, address, nationality, etc. Even information is published. This can be confirmed in the short selling statistics of the information data system of the Korea Exchange. In the case of major overseas countries, the amount of short selling by investor (UK, Germany, Japan) or the size of short selling by item (US) is selectively disclosed, which is considered to be less transparent than Korea.
Q. Since only Korea is using the T+2-day payment system instead of real-time payment, is it possible to short-sell without borrowing?
A. (Exchange/Securities Depository Response) Countries with open capital markets such as the United States, Japan, Germany and Hong Kong are adopting the T+2 payment method. This is because in an open market, it is inevitable to grant a period of at least one day or more for smooth settlement of foreign investors in different time slots. In general transactions such as asset management companies other than foreign investors, it takes more than a day to confirm the sale and approve payment. Until now, it has been pointed out that institutions and foreigners have abused the payment system to sell unowned stocks and buy same-day illegal short selling. Accordingly, the Korea Exchange plans to develop a new technique for detection and begin inspection from March.
Q. Hasn’t Korea only introduced a pre-blocking system for non-borrowing short selling?
A. (Exchange answer) It is understood that there is no country with a system that prevents illegal short selling in advance by checking the amount available for payment in real time when ordering short selling. Rather than being technically impossible to build a system, it is inefficient because it incurs excessive costs for the entire market including investors. Even if the system is established, various information for checking the balance must be concentrated in real time, and the speed of order settlement during the verification process is greatly reduced, which may lead to transaction delays or inconvenience to investors. In 2014, the United States reviewed the establishment of a real-time short selling position reporting system for the purpose of monitoring illegal short selling, but there is a case where the implementation was stopped because the possibility of realization was low and the cost for the effect was too high.
Q. Despite the prohibition of short selling, does Korea allow only market makers to sell short with preferential benefits, such as uptick rules and exemption from transaction tax?
A. (Exchange answer) Market makers play a role in reducing the transaction cost of investors by offering quotes in both the buy and sell directions. In the securities and derivatives markets, if the gap (spread) between buying and selling prices is widened, the transaction cost of investors may increase. Stocks with insufficient liquidity will be more disadvantageous than sufficient, but transaction costs will be reduced due to the market creation bid.
In addition, market makers must submit and maintain a sufficient quantity of quotes for both buying and selling in accordance with the exchange’s regulations. It is not possible to submit a very low asking price in order to artificially lower the price because it is necessary to submit a bid price at a higher price than the highest priority bid section.
It is not easy for stock market makers to purchase stocks for submitting bids in advance because they must submit bidirectional quotes at the same time. Therefore, it is necessary to borrow stocks in advance to secure stocks for smooth bid submission. At this time, short selling occurs. Market makers of derivatives may use short selling in the stock market to immediately hedge the risks associated with market creation in the derivatives market.
Major countries also recognize the significance of market makers and the necessity of short selling. In the case of six European countries banning short selling in March and the past ban on short selling in major countries, exceptions to market makers were allowed.
Exemption from the application of uptick rules for market makers and no transaction tax is also a system to support market-making activities. There is an opinion that only Korea gives market makers preferential treatment exemption from uptick rules and transaction tax. In principle, the U.S. and Japan are short-selling cities and, in principle, no uptick rules are enforced on anyone. In the case of the United States, there is no securities transaction tax, so there is no need to be exempted, and the UK and Hong Kong, which have a transaction tax, are exempt from the transaction tax of market makers in the same way as in Korea.
Recently, concerns have been raised about system abuse. Accordingly, short selling by market makers will be limited to cases where it is necessary and inevitable, and the uptick rule exemption for stock market makers will be abolished. Market creation targets will be reorganized to focus on low-liquidity stocks, and information such as market creation contract status and transaction details will be expanded.
Q. Compared to foreign countries, is the domestic stock lending and borrowing market much more advantageous for short selling?
A. (Korea Securities Depository and Securities Finance Answer) It is not true that the domestic stock lending and borrowing markets are more advantageous to investors in short selling than in major overseas countries. Stock lending and borrowing are off-the-shelf activities, and a lending contract is established by agreement between the lender and the borrower. The maturity of repayment is also determined by mutual agreement, and the borrower must repay it when the lender requests intermediate repayment. In this case, the borrower has to buy the stock or borrow from another lender, so it can be said to be a greater burden on the borrower than when the repayment period is fixed.
This lending structure is applied equally to major countries. Individual investors with relatively low creditworthiness compared to institutional investors are exposed to constant redemption risk if stocks are lent under the same conditions as institutional investors. An explicit redemption period (60 days) is guaranteed so that short selling positions can be maintained without restrictions within a certain period.
The claim that stocks can be borrowed without margin is also not true. In order to borrow stocks in the domestic lending market, it is necessary to provide the lender with collateral equal to or greater than the value of the stock to be borrowed. In the case of foreign lending markets, the margin and collateral ratio may be different from those in Korea, but it is common to pay collateral or margin when borrowing stocks.
It is also true that the claim that domestic stocks are borrowed by hand is also true. In the case of stock borrowing in Korea, communication is carried out through various communication means such as messenger, but the actual rental and borrowing transactions are carried out through intermediaries such as depository, securities finance, and securities companies. All stock loans and borrowings are stored and stored electronically in intermediaries. In accordance with the Capital Markets Act, which comes into force on April 6, those who borrow stocks for the purpose of short selling are obligated to keep information related to stock borrowing for five years.