South Korea’s short selling comeback
04 March 2025
With the anticipated return of short selling to South Korea, Daniel Tison sits down with industry experts to discuss if the green light will result in traffic
Image: stock.adobe.com/SeanPavonePhoto
After a series of regulatory enhancements, South Korea is reopening its securities finance market to the world by lifting its short selling ban on 31 March. While it may seem like a necessary step to establish the country as a competitive market in the global securities finance landscape, there are also concerns about potential implementation challenges.
The Financial Services Commission (FSC) of South Korea imposed a ban on short selling in November 2023, after it had discovered significant violations by foreign firms, including subsidiaries of the former Credit Suisse Group. These firms were fined for engaging in illegal short selling activities.
While short selling is an essential part of securities finance which improves market efficiency, the practice of selling shares without first borrowing them or even confirming their existence — known as naked short selling — is risky and now illegal in many jurisdictions, including the US, Europe, and most developed markets in Asia.
Lessons learnt: Closer monitoring and stronger penalties
A revision bill for the Financial Investment Services and Capital Markets Act (FSCMA), introduced in September 2024, requires institutional investors to set up their own electronic short sale processing system, with both institutional and corporate investors obliged to prepare relevant internal control standards.
Under the new regulations, the conditions for borrowing stocks will be equal for both institutional and retail investors to level the playing field, with a 105 per cent cash collateral ratio and guaranteed minimum 90-day repayment period.
In addition, the bill aims to enhance the effectiveness of punishment and sanctions by strengthening monetary penalties that can be imposed on unfair trading and illegal short sale activities. The new sanctions mechanisms include a ban on trading financial investment products and restriction from being appointed or serving as an executive at listed companies.
At the same time, the Korea Exchange (KRX) has been developing a naked short selling detection system (NSDS), which is to go live once the short selling ban has lifted. The FSC explains that the NSDS will receive information about the status of stock balance and over-the-counter (OTC) transactions from institutional investors, and compare it with their order history stored at the KRX to monitor and ensure detection of naked short selling activities within three days of orders being placed.
The financial regulator adds: “Through these measures, the authorities will work to foster a sound market environment, where short selling can be used as a proper trading strategy that can help to facilitate the market’s price discovery function. The authorities also expect that these measures will help to contribute to ensuring fair market order and trust for all market participants.”
A local source in South Korea told Securities Finance Times that many diverse and inconsistent regulations had caused chaos among market participants, undermining trust in the Korean financial market. However, he believes that the newly introduced regulations primarily focus on restoring trust among Korean retail investors. Additionally, these regulations are designed to enable most transactions to be systematically monitored, which is expected to reduce the likelihood of further confusing and unnecessary regulations in the future.
The knock-on effect and increased risk appetite
By reopening its borders to short selling, South Korea is expected to attract greater foreign investment and enhance its competitiveness among other Asian countries active in this sector, such as Japan, Hong Kong, or Singapore. By addressing regulatory gaps and aligning with international standards, the FSC aims to enhance market efficiency and investor confidence.
Stephen Howard, CEO of the Pan Asia Securities Lending Association (PASLA), believes that the return of short selling to South Korea will enable investors to hedge equity risk on a single-stock basis, which will increase risk appetite in the Korean market because investors will have more flexibility to manage their exposures.
He says: “If you are an issuer of an equity-linked product in the Korean market, the risk appetite to buy your product, such as a convertible bond, is probably quite low at the moment because the range of hedging solutions available to you is quite limited and prescriptive. [Lifting of the short selling ban] expands that range of hedging solutions, which means that you become more investable for that type of product.”
Secondly, short selling helps with price information in the market, making it clearer whether stocks are over or undervalued. This improves the pricing of derivatives, structured products, and above all equity securities, as these particularly rely on accurate price discovery. Investors with long-term positions can use short selling to manage portfolio risks more efficiently.
“[Short selling] is making that price discovery more visible,” says Howard. “It’s making that price formation process for derivatives more accessible, and therefore, hopefully, a little bit more effectively and efficiently priced for market participants.”
Last but not least, short selling increases demand for borrowing stocks, which in turn stimulates securities lending. This leads to more activity in asset financing and collateralised transactions, benefiting the broader financial ecosystem.
Howard says: “The knock-on effect for this would be that it’s going to create a demand and stimulus for borrowing and lending of securities and the financing of assets, which can only be a positive for the securities finance market as a whole.”
Overall, Howard suggests looking at it top-down, starting with how short selling affects a range of risk management tools, then the market participants’ activity, and finally how it drives demand for securities lending.
“You sort of cascade through,” he says. “It makes a lot more sense because the short sale mechanism is more effective and utilised by the market risk participants than anybody else.”
Testing the waters
With the scheduled ban-lifting, South Korea’s securities lending market is poised to gain momentum, but the international implications will depend on various factors. The FSC’s reforms signal a commitment to developing a transparent and efficient financial ecosystem. However, the effectiveness of the regulatory framework is yet to be tested. As the March 2025 deadline approaches, the focus will be on ensuring a smooth and transparent transition to this new phase.
According to a financial services firm in South Korea, it is difficult to expect a sudden change, but many investors who had previously overlooked the Korean market are now turning their attention back to it. Therefore, the foreign participation rate in the Korean market, which has sharply declined over the past few years, is expected to increase.
Looking ahead, Howard says: “It would be disingenuous to say, or to think even, that the market will switch on like a dime on 31 March – I cannot imagine that would be the case.
“What we would expect to see, like with any new market opening or reopening, would be a series of test trades undertaken by market professionals in a variety of different ways – market professional to another market professional, offshore to an onshore entity, and so on and so forth, so that they get a high level of confidence over that transaction activity. This will also give all stakeholders that same high level of confidence in the market structure.”
The Financial Services Commission (FSC) of South Korea imposed a ban on short selling in November 2023, after it had discovered significant violations by foreign firms, including subsidiaries of the former Credit Suisse Group. These firms were fined for engaging in illegal short selling activities.
While short selling is an essential part of securities finance which improves market efficiency, the practice of selling shares without first borrowing them or even confirming their existence — known as naked short selling — is risky and now illegal in many jurisdictions, including the US, Europe, and most developed markets in Asia.
Lessons learnt: Closer monitoring and stronger penalties
A revision bill for the Financial Investment Services and Capital Markets Act (FSCMA), introduced in September 2024, requires institutional investors to set up their own electronic short sale processing system, with both institutional and corporate investors obliged to prepare relevant internal control standards.
Under the new regulations, the conditions for borrowing stocks will be equal for both institutional and retail investors to level the playing field, with a 105 per cent cash collateral ratio and guaranteed minimum 90-day repayment period.
In addition, the bill aims to enhance the effectiveness of punishment and sanctions by strengthening monetary penalties that can be imposed on unfair trading and illegal short sale activities. The new sanctions mechanisms include a ban on trading financial investment products and restriction from being appointed or serving as an executive at listed companies.
At the same time, the Korea Exchange (KRX) has been developing a naked short selling detection system (NSDS), which is to go live once the short selling ban has lifted. The FSC explains that the NSDS will receive information about the status of stock balance and over-the-counter (OTC) transactions from institutional investors, and compare it with their order history stored at the KRX to monitor and ensure detection of naked short selling activities within three days of orders being placed.
The financial regulator adds: “Through these measures, the authorities will work to foster a sound market environment, where short selling can be used as a proper trading strategy that can help to facilitate the market’s price discovery function. The authorities also expect that these measures will help to contribute to ensuring fair market order and trust for all market participants.”
A local source in South Korea told Securities Finance Times that many diverse and inconsistent regulations had caused chaos among market participants, undermining trust in the Korean financial market. However, he believes that the newly introduced regulations primarily focus on restoring trust among Korean retail investors. Additionally, these regulations are designed to enable most transactions to be systematically monitored, which is expected to reduce the likelihood of further confusing and unnecessary regulations in the future.
The knock-on effect and increased risk appetite
By reopening its borders to short selling, South Korea is expected to attract greater foreign investment and enhance its competitiveness among other Asian countries active in this sector, such as Japan, Hong Kong, or Singapore. By addressing regulatory gaps and aligning with international standards, the FSC aims to enhance market efficiency and investor confidence.
Stephen Howard, CEO of the Pan Asia Securities Lending Association (PASLA), believes that the return of short selling to South Korea will enable investors to hedge equity risk on a single-stock basis, which will increase risk appetite in the Korean market because investors will have more flexibility to manage their exposures.
He says: “If you are an issuer of an equity-linked product in the Korean market, the risk appetite to buy your product, such as a convertible bond, is probably quite low at the moment because the range of hedging solutions available to you is quite limited and prescriptive. [Lifting of the short selling ban] expands that range of hedging solutions, which means that you become more investable for that type of product.”
Secondly, short selling helps with price information in the market, making it clearer whether stocks are over or undervalued. This improves the pricing of derivatives, structured products, and above all equity securities, as these particularly rely on accurate price discovery. Investors with long-term positions can use short selling to manage portfolio risks more efficiently.
“[Short selling] is making that price discovery more visible,” says Howard. “It’s making that price formation process for derivatives more accessible, and therefore, hopefully, a little bit more effectively and efficiently priced for market participants.”
Last but not least, short selling increases demand for borrowing stocks, which in turn stimulates securities lending. This leads to more activity in asset financing and collateralised transactions, benefiting the broader financial ecosystem.
Howard says: “The knock-on effect for this would be that it’s going to create a demand and stimulus for borrowing and lending of securities and the financing of assets, which can only be a positive for the securities finance market as a whole.”
Overall, Howard suggests looking at it top-down, starting with how short selling affects a range of risk management tools, then the market participants’ activity, and finally how it drives demand for securities lending.
“You sort of cascade through,” he says. “It makes a lot more sense because the short sale mechanism is more effective and utilised by the market risk participants than anybody else.”
Testing the waters
With the scheduled ban-lifting, South Korea’s securities lending market is poised to gain momentum, but the international implications will depend on various factors. The FSC’s reforms signal a commitment to developing a transparent and efficient financial ecosystem. However, the effectiveness of the regulatory framework is yet to be tested. As the March 2025 deadline approaches, the focus will be on ensuring a smooth and transparent transition to this new phase.
According to a financial services firm in South Korea, it is difficult to expect a sudden change, but many investors who had previously overlooked the Korean market are now turning their attention back to it. Therefore, the foreign participation rate in the Korean market, which has sharply declined over the past few years, is expected to increase.
Looking ahead, Howard says: “It would be disingenuous to say, or to think even, that the market will switch on like a dime on 31 March – I cannot imagine that would be the case.
“What we would expect to see, like with any new market opening or reopening, would be a series of test trades undertaken by market professionals in a variety of different ways – market professional to another market professional, offshore to an onshore entity, and so on and so forth, so that they get a high level of confidence over that transaction activity. This will also give all stakeholders that same high level of confidence in the market structure.”
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