Recent Changes to the Korean Short Sale Rules

Following the announcement of the “Proposed Improvement Measures for the Korean Short Sale Regime” (the “Proposed Measure on Short Sale Regime”) in June 2024 by the joint consultation group consisting of the Financial Services Commission (the “FSC”), the Financial Supervisory Service (the “FSS”), the Korea Exchange (the “KRX”) as well as the ruling party (Link), various stakeholders have prepared and developed concrete implementation measures. On August 12, 2024, the Korea Securities Depository (the “KSD”) announced proposed amendments to the “Regulation on Intermediation of Securities Lending and Borrowing Transactions” and subordinate regulation (the “Proposed KSD Regulation Amendments”). On August 21, the FSS released the guidelines for short sale internal controls and inventory management system in the form of an administrative guidance (the “Short Sale Internal Control and Systems Guidelines”) (Link). Finally, on August 28, the proposed amendments to the Financial Investment Services and Capital Markets Act (the “FSCMA Amendments”) containing, among other things, strengthened penalty for failure to prevent short sale breaches and market abuse conduct passed the National Policy Committee of the Korean National Assembly and are expected to become effective at the end of September or early October upon resolution at the plenary session of the National Assembly.

Status of Proposed Improvement Measures

1.	The FSCMA Amendments The key obligations and restrictions introduced under the proposed amendment to the FSCMA are as follows:

Measures

Details

Obligations on investors and local brokers to prevent naked short sale

①	Corporate investors* intending to short sell listed Korean securities are required to adopt and implement internal control standards and inventory management system.

*Corporate investors that are subject to these requirements are as follows:

Short sale internal control standards requirement: All corporate investors who intend to short sell listed Korean securities.
Inventory management system requirement: Corporate investors who (i) for one day or more since January 1, 2023, have held a net short position balance in respect of a relevant listed Korean security exceeding 0.01 percent of all issued shares of relevant security or amounting to KRW 1 billion or more in notional amount, or (ii) plan to hold such net short position in the future.

②	Brokers must check whether a corporate investor has adopted and implemented requisite short sale internal control standards and systems before accepting short sale orders from the corporate investor.

Limitations on maximum term of securities borrowing which is executed for the purpose of short selling

①	Securities lending and borrowing transactions executed for the purpose of placing covered short sell order must stipulate the term* of the borrowed securities.

*Under the Proposed KSD Regulation Amendments, the term of the securities lending and borrowing transactions executed for short sale cannot exceed 90 days from the execution date, and while the term could be subsequently rolled over by the parties’ agreement, the total term cannot exceed 12 months.

②	Agents, brokers and arrangers of the securities lending and borrowing transactions are required to ensure that the borrowers comply with the limits on terms by managing the borrowing transactions based on the purpose of transactions as notified by the borrower.

Heavier penalties for unfair trading activities

①	Similar to the case of other types of unfair trading activities, a person that has engaged in naked short sale would be subject to aggravated criminal penalty of imprisonment,* depending on the amount of profit generated or loss avoided from naked short sale.

*The following aggravated penalties would apply:

Amount of profit generated (or loss avoided)	Aggravated penalty
KRW 5 billion or more	Minimum imprisonment of five years and up to life imprisonment
KRW 500 million or more and less than 5 billion	Minimum imprisonment of three years
Less than KRW 500 million	Minimum imprisonment of one year

②	A person who commits insider trading, market manipulation, fraudulent trading or naked short sale may be subject to criminal fine of up to four to six times (increased from three to five times) the profit generated or loss avoided from relevant illegal conduct.

③	The FSC may prohibit a person who has engaged in certain prescribed unfair trading activities* from trading financial investment products for that person’s account or, for individuals, being appointed as an executive of a listed Korean company, in each case for up to five years.

*The prescribed unfair trading activities are: (i) leakage or use of material information related to listed derivatives; (ii) insider trading; (iii) market manipulation; (iv) fraudulent unfair trading; (v) market disruption; (vi) naked short sale, and (vii) acquisition of securities in breach of prohibition imposed on short sellers.

④

If there is convincing evidence indicating that a person has committed one of the prescribed unfair trading activities and if there is convincing justification to determine that suspension of financial transaction is necessary, the FSC may instruct financial companies to suspend relevant trading account(s).

Restrictions on acquisition of convertible bonds and bonds with warrant by short sellers

①	In addition to the existing prohibition on participation of the rights offering by short sellers, the amendment will introduce prohibition on acquisition of convertible bonds and bonds with warrant by short sellers.

Short Sale Internal Control and Systems Guidelines

With release of the Short Sale Internal Control and Systems Guidelines from August 21, 2024, the FSS also circulated a checklist intended for the Korean broker’s review of appropriateness of the investors’ short sale compliance system. Accordingly, all corporate investors who intend to engage in covered short sale involving listed Korean securities are required to implement the guideline for short sale internal controls and internal inventory management system as necessary and also obtain confirmation of regulatory compliance from their local securities brokers. Please refer to our newsletter from August 2024 (Link) for additional information.

3.	Proposed Amendments to the KSD Regulations The Proposed KSD Regulation Amendments set forth limitations on the terms of securities lending and borrowing transactions related to covered short sell orders and clarifications regarding standards on recall of loaned securities, as summarized below.

Measures	Details
Limitations on maximum term of the securities lending and borrowing transactions executed for the purpose of short sale	The term of the securities lending and borrowing transactions executed by a borrower for the purpose of placing covered short sell order cannot exceed 90 days from the execution date of relevant transactions, provided that the final redemption date may be extended based on the parties’ agreement but even in such case the total term of relevant transactions must be less than 12 months.
Clarification on recall processes of the loaned securities	Under the existing KSD regulations, if a lender requests early redemption of the loaned securities before 12 p.m. on a given day, the borrower is required to return the securities within three business days from the date of the request (counting the date of request as the first business day, i.e., T+2). If a lender’s early redemption request was made on or after 12 p.m. on a given day, the borrower is required to return the securities within four business days from the date of the request (i.e., T+3). In the cases where a lender places a sell order for the loaned securities and makes an early redemption request on the same day but on or after 12 p.m., as the borrower is required to return the loaned securities by T+3 under the existing KSD regulations, there was a possibility that the loaned securities would not be returned in time for settlement, thereby creating a risk of settlement failure. To address such risk, the Proposed KSD Regulation Amendments allow the parties to agree otherwise, notwithstanding the early redemption timeline set forth therein, so that the borrower could be obligated to return the loaned securities by T+2 or earlier even when the lender makes an early redemption request on or after 12 p.m. on T.
Inclusion of trading suspension as termination event of the securities borrowing transactions	Under the Proposed KSD Regulation Amendments, in case the maturity of a securities lending and borrowing falls during the period of trading suspension, the maturity would be postponed until the trading suspension is lifted.
Establishment of process for handling stock dividends	The Proposed KSD Regulation Amendments provide that the lender and the borrower of an existing securities lending and borrowing transaction would be deemed to have entered into a securities lending and borrowing transaction with the same terms and conditions in respect of the stock dividends which are paid during the term of the existing securities borrowing transactions.

In light of the new rules and processes which have been or will soon be implemented as explained above, the investors who intend to engage in short sale trades involving Korean listed securities (that is, after the lifting of the current short sale ban) and local securities brokers who facilitate such trades are advised to thoroughly review new rules and processes and make necessary preparations in advance.

[Korean Version]

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