On July 28, 2022, the Financial Services Commission (the “FSC”), the Supreme Prosecutors′ Office, the Financial Supervisory Service (the “FSS”) and the Korea Exchange (the “KRX”) held an inter-agency meeting and announced their plans to strengthen the regulation of short sale rules, punishment of illegal short sales and  improvement of short sale regulations.

The plans announced in the official press release (the “Press Release”) are in response to President Suk-yeol Yoon’s request on July 27, 2022 to come up with measures to eradicate illegal activities involving short sale trade.  The Press Release is expected to be followed by swift actions strengthening the oversight and punishment of illegal short sales and changes in the short sale regime in Korea.

In relation to the strengthened oversight and punishment of illegal short sales, the FSS announced its detailed plans, including special investigations of unfair trade practices involving short sales, an expedited investigation of cases transferred from the KRX, vigorous imposition of administrative fines, and active responses through the fast track process.*  The Supreme Prosecutors’ Office indicated that it plans to actively utilize the fast track process in close coordination with the Securities Crime Joint Investigation Team of the Seoul Southern District Prosecutors’ Office and vigorously enforce short sale rules by commencing investigations in a timely manner and imposing severe penalties for short sale violations including seizure of criminal proceeds.  In addition, the KRX plans to conduct thematic audits with respect to short sale trades involving stocks with excessive trading volume, stocks included in indices and public disclosure of material negative information, and also check the short sale process and internal controls within securities firms that engage in large volume short sale trades.

*Fast track process: This process allows for the prompt commencement of criminal investigations of unfair trading cases and provides for mandatory investigative measures such as search and seizure at an early stage of the investigation.

The key measures announced in the Press Release to monitor and penalize illegal short sales and to improve the short sale system in Korea are as follows:
 

The measures intended to strengthen the investigation and punishment of illegal short sales described in the above table will be implemented immediately, while the measures that require amendments to relevant laws and/or regulations are scheduled to be implemented within this year as follows:

• Q3 of 2022

  • Improvement of the excessive short selling stock designation system (through amendments to relevant detailed rules of the KRX)

• Q4 of 2022 

  • Strengthened monitoring of stock borrowing transactions such as the introduction of (i) mandatory reporting requirements for the lending/borrowing transactions for 90 days or longer and (ii) inclusion of the information on stock borrowing in the net short position reports (through amendments to the Financial Investment Business Regulations)
  • Decrease in the collateral ratio for retail investors’ short sale trades (through amendments to the Financial Investment Business Regulations and changes to the IT systems of securities firms)

Following the previous inter-agency joint announcement relating to short sales on July 28, 2022 as described above, on August 8, 2022, the Chairman of the FSC Joo-hyun Kim, during his briefing to President Yoon, vowed to strengthen financial investor protection and restore confidence in financial markets by strengthening the investigation and punishment of illegal short sales, implementing new reporting requirements for long-term stock borrowing (90 days or longer) and expanding the system to designate excessive short selling stocks.

In addition, during the emergency meeting held to assess the financial market conditions on August 29, 2022, the FSS announced a plan to (i) newly establish the short sale investigation team to facilitate prompt investigations and vigorous punishments of illegal short sales and (ii) improve the market’s overall compliance with applicable rules and regulations by enhancing its supervision and inspection capabilities over the short sale activities.

Chairman Kim′s recent remarks and the FSS’s announcement highlight the current administration′s focus on vigorous monitoring of short sales which may lead to investigations into the short sale practice of various market participants.  In particular, as the joint announcement noted that the authorities would examine the adequacy of short sale processes and the compliance with short sale rules by foreign financial institutions, we believe that the regulators would be interested in the overall systems and processes for short sales, including confirmation of stock borrowing, recall of stock loans, operation of aggregation units, net short position reporting and disclosure, and flow of equity swaps and related hedging activities.