Recent Changes to Korean Short Sale Rules

Following the announcement of the “Proposed Improvement Measures for the Korean Short Sale Regime” (the “Proposed Measures on Short Sale Regime”) in June 13, 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”) and others (Link), the Korea Securities Depository (the “KSD”) announced proposed amendments to the “Regulation on Intermediation of Securities Lending and Borrowing Transactions” and its subordinate regulation on August 12, 2024 (the “Proposed KSD Regulation Amendments”). On August 21, the FSS released the guidelines for short sale internal controls and inventory management systems in the form of an administrative guidance (the “Short Sale Internal Control and Systems Guidelines”) (Link). Finally, on September 26, the proposed amendments to the Financial Investment Services and Capital Markets Act (the “FSCMA Amendments”) containing, among others, strengthened penalties for failure to prevent short sale breaches and unfair trade practices, were passed by the plenary session of the Korean National Assembly and will take effect on March 31, 2025.

1.	FSCMA Amendments The key obligations and restrictions in the FSCMA Amendments are as follows:

Measures

Details

Investors and Local Brokers’ Obligations to Prevent Naked Short Sales

①	Corporate investors^[1] intending to short sell listed Korean securities are required to adopt and implement internal control standards and inventory management systems

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

Limitations on Maximum Term of Securities Lending and Borrowing Transactions for Short Selling

①	Securities lending and borrowing transactions executed to place a covered short sale order must stipulate the term^[2] of the securities

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

Heavier Penalties for Unfair Trading Activities

①	Similar to cases of other types of unfair trading activities, a person that has engaged in a naked short sale would be subject to aggravated criminal penalty of imprisonment,^[3]which is defined depending on the amount of profit generated or loss avoided from the naked short sale

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

③	The FSC may prohibit a person who has engaged in certain prescribed unfair trading activities^[4]from (a) trading financial investment products for his/her account, or (b) being appointed as an executive of a listed Korean company for up to five years

④

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

Restrictions on Acquisition of Convertible Bonds and Bonds with Warrants by Short Sellers

①	In addition to the existing prohibition on short sellers’ participation in rights offerings, the amendment will introduce a prohibition on the acquisition of convertible bonds and bonds with warrants by short sellers

Short Sale Internal Control and Systems Guidelines

With the release of the Short Sale Internal Control and Systems Guidelines from August 21, 2024, the FSS also circulated a checklist intended for Korean brokers’ review of the appropriateness of investors’ short sale compliance systems. Accordingly, all corporate investors who intend to engage in covered short sales involving listed Korean securities are required to implement the Short Sale Internal Control and Systems Guidelines and also obtain confirmation of regulatory compliance from their local securities brokers.

Proposed KSD Regulation Amendments

The Proposed KSD Regulation Amendments set forth limitations on the term of securities lending and borrowing transactions related to covered short sale orders and provide clarification regarding standards on the recall of loaned securities, as summarized below:

Measures	Details
Limitations on Maximum Term of Securities Lending and Borrowing Transactions Executed for Short Selling	The term of the securities lending and borrowing transactions executed by a borrower for the purpose of placing a covered short sale order cannot exceed 90 days from the execution date of the 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 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, a 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)), and if the lender’s early redemption request was made at 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 cases where the lender places a sale order for the loaned securities and makes an early redemption request on the same day but at 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, such as in the case of a securities lending transaction under the Global Master Securities Lending Agreement, notwithstanding the early redemption timeline set forth therein, so the borrower could be obligated to return the loaned securities by T+2 or earlier even when the lender makes an early redemption request at or after 12 p.m. on T (the day of the sale)
Inclusion of Trading Suspension as Reason for Termination of Securities Lending and Borrowing Transactions	Under the Proposed KSD Regulation Amendments, in case the maturity of a securities lending and borrowing transaction 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 with respect of the stock dividends that 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 current short sale ban is lifted) and local securities brokers who facilitate such trades need to thoroughly review the new rules and processes and prepare in advance.

[1]

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 with respect to a relevant listed Korean security exceeding 0.01% of all issued shares of the 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]

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

[3]

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

[4]

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 sales, and (vii) acquisition of securities in breach of prohibition imposed on short sellers.

[Korean Version]

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