South Korea’s financial authorities have described illegal naked short selling as “rampant”, a claim they used to justify a surprise ban on all forms of short selling in the US$1.8 trillion equity market in November. 

But after scouring more than two years of transaction records at global investment banks for evidence of wrongdoing, the Financial Supervisory Service (FSS) has turned up just 110 billion won (S$111 million) worth of alleged naked short sales – an act of selling shares without borrowing them first. 

The total – including an FSS announcement on Sunday (Jan 14) that two more banks violated rules – is equivalent to 0.001 per cent of the total value of South Korean shares traded in 2022 and 2023, indicated Bloomberg calculations based on exchange and FSS data. That is also just 0.04 per cent of total short selling value traded during the two years. In comparison, about US$1.4 billion worth of Samsung Electronics shares changed hands in a single day last week.

While the FSS probe is ongoing and its findings do not include bank clients’ conduct, the relatively tiny sum of problematic trades unearthed so far likely gives weight to critics who have questioned the justification for a complete ban on short selling in Asia’s sixth-biggest stock market. They see the move as politically motivated in the run-up to parliamentary elections in April. 

Individual investors in South Korea – accounting for nearly 30 per cent of its population of roughly 50 million – often blame short sellers for market downturns. But the authorities’ moves “aren’t really helpful to the development of Korea’s capital markets”, said Lyndon Chao, managing director at Asia Securities Industry & Financial Markets Association (ASIFMA). 

“It’s simply not true that illegal short selling is rampant in Korea, certainly not by the global community,” Chao added. “Short selling takes up a very, very small percentage of overall trading volumes, so it’s just illogical and irrational to say that because of this very small percentage of trading that’s shorting the market.” 

GET BT IN YOUR INBOX DAILY

Start and end each day with the latest news stories and analyses delivered straight to your inbox.

Sign UpVIEW ALL

The small number of naked short selling does not mean there have been no wrongdoings, an official at regulator Financial Services Commission said in response to queries from Bloomberg News. 

The focus of the latest investigations does not include rule violations by investment banks’ end-clients such as hedge funds, said a senior FSS official, speaking anonymously to discuss ongoing investigations. 

South Korea launched a 20-person special investigation team at the watchdog FSS in November. The team aimed to probe all short-selling activities since May 2021 by major global investment banks that most actively handle such trades in the country.

The probe launch came after authorities accused in October two global banks of “routinely and intentionally” breaching short-selling rules in trades totalling 56 billion won. The two banks – BNP Paribas and HSBC Holdings – along with BNP’s local brokerage unit were fined a combined 26.5 billion won, and could face investigations by prosecutors. 

In the FSS’ Sunday update to its investigation, the watchdog said two other global investment banks conducted 54 billion won worth of illegal short selling on five South Korean stocks. The watchdog, without naming the banks, said it would seek to impose fines.  

“Those suspicions that there has been market disturbance by illegal short selling were true,” the FSS said in a statement on Sunday. 

South Korea has prohibited any kind of stock short selling until the end of June, vowing to root out illegal trades that it said have hurt trust and fairness in the market. 

President Yoon Suk Yeol also expressed his support for the ban, saying the measure will stay in place until an improvement is made in the short-selling trade systems. Illegal short sellers cause “great losses to retail investors”, he said. 

The global investment banking industry and the South Korean authorities appear to have different definitions on what “rampant” means, said Lee Hyo Seob, senior research fellow at Korea Capital Market Institute.

“It appears that there have been a habitual ignorance of rules in the investment banking industry where there have been mismatches between the number of stocks that were shorted and the number of stocks that have been borrowed, as those numbers did not match in real time,” Lee noted. The figures could be just a tip of the iceberg, he added. 

Many of the cited violations, while perhaps illegal, constituted mere operational and technical breaches and were not malicious activities, according to ASIFMA’s Chao. “Mistakes will always happen no matter how much people try to mitigate,” he said. Bloomberg