Tougher rules on short-selling pose a threat to South Korea’s burgeoning securities lending market.
An automated disclosure system and next day short sale bans on “overheated stocks” have been phased in by the country’s bourse, Korea Exchange (KRX).
Meanwhile, two lawmakers (elected politicians) are considering a sixty day borrowing limit restrictions and a total ban on short-selling in the KOSDAQ market.
Korea’s Financial Services Commission (FSC), however, is not supportive of the additional changes.
“Such measures, if approved, would have a strong impact on Korea’s securities lending market,” said Jason Wells, a Hong Kong-based vice president at State Street.
He added that the regulators are in fact walking a fine line in an attempt to safeguard a robust short selling market as they realise the benefits that it brings to liquidity and confidence in the market.
"The FSC is making necessary tweaks to disclosure, penalties for breeches of reporting obligations and enhancing circuit breakers all in an effort not to go back to the dark days of a full shut down of the short selling market."
Korea’s Financial Services Commission (FSC) decided to tighten rules last year following heavy losses for investors of Hanmi Pharmaceutical.
Massive short-selling before the company disclosed that a contract with Boehringer Ingelheim broke down caused the firm’s share price to crash.
At the time of the global financial crisis, South Korea banned all short-selling.
That ban was lifted for most companies in June 2009 and restrictions on financial stocks were loosened in 2013.
Quant funds are active in Korea and generally operate with a neutral market bias so look to hedge their long positions with shorts.
The local hedge fund industry has also been active with long/short strategies and expanding in to the convertible bond space. All of this requires short access.
Seiwoon Hwang, chief economist, Korea Capital Market Institute, said there remains a "negative perception" on short selling in South Korea and the country's retail investor base continues to have strong influence on regulatory decisions.
This week institutional market participants attending the PASLA/RMA securities lending event in Seoul voiced their concerns.
More than 55% of the audience agreed that short-selling modifications were the most influential rule changes impacting the country’s securities lending market.
One individual told Global Investor/ISF that there was an element of “political posturing” occurring on the part of Korean financial officials.
Another added that certain US beneficial owners holding Korean equities are starting to ask their agents about potential penalties and what they can do to circumvent the risks.
The crackdown comes amid continued growth for South Korea's securities lending industry.
Since 2010, stock and bond lending balances have increased at an average annual rate of 27% and 8% respectively.