South Korea’s financial authorities have announced their intention to impose record fines on two global investment banks for engaging in illegal short selling activities. The banks, based in Hong Kong, are accused of violating the rules on short selling by selling stocks without borrowing them first. This practice, known as naked short selling, is considered illegal in South Korea and could have given the banks an unfair advantage over other market participants.
What is Short Selling and Why is it Illegal?
Short selling is a trading strategy that involves selling borrowed stocks and buying them back later at a lower price, hoping to profit from the difference. Short sellers usually bet on the decline of stock prices, and they can provide liquidity and price discovery to the market. However, short selling also carries risks and can have negative impacts on the market, such as creating downward pressure on stock prices, spreading false rumors, and manipulating the market.
Naked short selling is a more extreme form of short selling that involves selling stocks without even borrowing them first. This means that the seller does not have to pay any fees or interest to the lender, and does not have to deliver the stocks to the buyer on time. Naked short selling can create artificial supply and demand in the market, distort the price signals, and harm the interests of other investors.
Naked short selling is illegal in many countries, including South Korea, where it has been banned since 2008. The Financial Services Commission (FSC), the top financial regulator in South Korea, has been enforcing strict rules and penalties on illegal short selling activities, especially after the COVID-19 pandemic triggered a market turmoil in 2020. The FSC has also extended a temporary ban on all short selling activities until May 2024 to protect the market stability.
How Did the Global Banks Violate the Rules?
According to the Financial Supervisory Service (FSS), the financial watchdog under the FSC, two global investment banks based in Hong Kong have been found to have engaged in naked short selling in several securities between 2021 and 2022. The FSS said that the banks’ actions were “routine and intentional”, and that they could have reaped extra profits from them.
The FSS did not disclose the names of the banks or the exact amount of the fines, but said that they would be the highest on record, given the size and duration of the naked short selling orders. The current record is a 3.9 billion won ($2.9 million) fine imposed on Erste Asset Management earlier this year.
The FSS said that it plans to finalize its decision after consulting with a committee at the FSC, and that it will disclose the identities of the banks to the public after future proceedings. The FSS also said that it will expand its investigation into other global investment banks and seek cooperation from its counterpart in Hong Kong.
How Did the Retail Investors React?
The news of the planned fines has been welcomed by many retail investors in South Korea, who have been protesting against illegal short selling practices for a long time. Retail investors are individual investors who trade stocks using their own money, and they make up a large portion of South Korea’s stock market. Retail investors have often felt disadvantaged and victimized by institutional investors, especially foreign ones, who have more resources and information.
Retail investors have also been frustrated by the temporary ban on all short selling activities, which they believe has limited their trading options and opportunities. Some retail investors have even organized online campaigns to drive up the prices of stocks targeted by short sellers, such as GameStop in the US.
Retail investors have urged the financial authorities to lift the ban on legal short selling activities, while cracking down on illegal ones. They have also demanded more transparency and accountability from the financial institutions involved in short selling activities.
South Korea’s financial authorities have said that they will consider lifting the ban on legal short selling activities gradually after May 2024, depending on the market conditions and public opinion. They have also said that they will continue to monitor and regulate short selling activities to ensure fair and orderly market operations.
