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Crackdown on Illicit Short-Trading Rocks South Korean Stock Market

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Michael Chen

May 6, 2024 - 03:16 am

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Global Banks in South Korea Caught in $156 Million Illegal Short Trade Scandal

South Korea's vigilant financial regulatory body has unearthed a staggering 211.2 billion won (equivalent to $156 million) in illicit short-selling trades carried out by nine global investment powerhouses, detailing the latest advancement in an exhaustive investigation that initiated in the latter months of the previous year.

Unprecedented Violations Amidst Financial Crackdown

The identity of these nine banking giants remains under wraps, as disclosed during an authoritative brief by the Financial Supervisory Service (FSS). The banks are accused of undermining procedural norms, resulting in unauthorized short sales across a diverse mix of 164 stocks. Further examination of five additional banking institutions continues as the FSS intensifies efforts to untangle this complex web of transgressions.

Penalties loom over two of the embattled banks, already embroiled in punitive measures doled out by financial overseers, and now stand at the threshold of prosecutorial scrutiny for purported infringements of South Korea’s Capital Markets Law, as per the insight provided by Hahm Yong-il, senior deputy governor at the FSS in a recent press engagement. The fate of the remaining banks hangs in the balance as the FSS contemplates subsequent penal actions.

The Fight Against Naked Short Selling

The actions of these major banks and hedge funds have been placed under a proverbial microscope in South Korea of late. The nation is fortifying its stand against ‘naked short selling’ – the controversial practice of selling shares without forehand procurement or borrowing. Although short selling is sanctioned in several markets across the globe, it stirs up political debate in South Korea where it is commonly a target of blame by ardent retail investors for downturns in stock prices.

A bold move in November ushered in a prohibition of all varieties of short selling, set to span until June 2024, stirring discord among select investors who fear that this could detract from the market's allure to global financing entities.

Crackdown on Global Investment Banks

Concurrent with this ban, a specialized task force was mobilized to scrutinize the entirety of short-selling ventures engaged by preeminent global investment banks post-May 2021. This period marks the moment when South Korea cautiously re-adopted short selling for equities listed on the Kospi 200 Index and the Kosdaq 150 Index subsequent to a hiatus attributed to the pandemic.

According to the FSS, the predominant impetus for the global banks' short selling activities in Korea was to strategically manage their swap deals with clients. Banks from Europe were noted for a higher number of infractions in comparison to their American counterparts, with most of the dubious trading emanating from their Hong Kong branches. Furthermore, officials from the FSS have planned an official visitation to Hong Kong later this month, with an agenda to elucidate upon Korea’s regulatory stance concerning short-selling.

Navigating the Regulatory Landscape

Hahm clarified that the majority of the discovered naked short-selling transactions by these nine financial institutions were predominantly associated with the logistical aspect of stock balance regulation, such as deficits in the volume of borrowed shares. These violations were mainly detached from utilization of nonpublic information or other forms of unfair trading practices which are subject to criminal prosecution.

The fourteen global banking establishments currently under the prying eyes of regulators make up a hefty 90% of all short-selling transactions executed by foreign entities within the Korean market, the FSS reveals.

Strengthening Surveillance with Technology

In a bid to reinforce the oversight of market operations, a sophisticated platform designated for monitoring short-selling is undergoing development. This system aims to assist in pinpointing illegal transactions. While the current ban on the controversial practice is intended to last until the completion of June, President Yoon Suk Yeol has signaled the possibility of extending this restriction until the launch of an effective electronic supervision system.

The escalating sequence of events that led to this rigorous probe was spurred by allegations against two global banking leaders in October. They were charged with 'routinely and intentionally' overlooking rules pertinent to short selling, implicating trades totalling an approximate 56 billion won.

A String of Financial Reprimands

Later in December, both BNP Paribas SA and HSBC Holdings Plc faced monetary penalties enforced by the regulatory watchdogs for breaches associated with short selling activities. In a more recent development as of March this year, HSBC’s Hong Kong division alongside three of its traders were formally indicted by prosecutors. Credit Suisse, which underwent acquisition by UBS Group AG, also found itself on the receiving end of financial penalties, as reported by the local Korean press earlier in the month.

Read more about the implications of short selling in South Korea in the Bloomberg article: Why South Korea Banned Short Selling and What’s Next: QuickTake

The Global Context of Investment Practices

The incidents unfolding in South Korea reflect a broader scrutiny placed upon global banks' operations and compliance infrastructures. With the rise of sophisticated investment strategies and financial instruments, the line between regulation and innovation has become increasingly blurred. The discrepancy in the application of rules amongst different jurisdictions poses challenges for multinational banks which operate across borders, adhering to a patchwork of regulatory environments.

Looking Ahead: Regulations and Market Stability

South Korea’s proactive stance showcases a commitment to ensuring a fair and stable marketplace for its investors. The country's willingness to impose stringent measures and develop sophisticated tracking systems signifies an evolutionary leap in the way financial markets are policed. As the landscape for capital markets continues to evolve, the balance between fostering innovation and maintaining robust regulatory frameworks will be pivotal. South Korea's current predicament may well serve as a case study for other emerging markets aiming to attract international investment while safeguarding their financial ecosystems.

Implications for Institutional Investors

For institutional investors, the South Korean saga underscores the need for vigilance and rigorous adherence to local regulations. As countries tighten controls on market practices, banks must enhance their compliance measures to avoid punitive outcomes that could impact their operations and reputation. Furthermore, the case stresses the importance of transparent and responsible trading practices within the financial community, potentially prompting calls for broader international standardization of short-selling regulations.

Ensuring Compliance in a Dynamic Financial World

The importance of compliance cannot be overstated in today’s rapidly changing financial universe. Global banks are pressured to remain agile, updating their practices to conform to the dynamic regulatory requirements across various markets. South Korea's stringent monitoring of short-selling activities sets a precedent and may embolden regulators in other countries to implement similar measures. This can lead to a more cohesive global financial environment where the risk of contravention diminishes and integrity in transactions becomes the norm.

Conclusion: A Quest for Transparency

The intensive investigation by South Korea's Financial Supervisory Service reflects a larger quest for transparency and accountability in the world of finance. This probe, revealing significant illegal short trades by global investment banks, not only sends a strong message against malpractices but also reassures market participants that robust safeguards are in place. As global financial entities navigate through the intricate tapestry of local and international laws, the spotlight remains on the effectiveness of regulatory agencies in upholding the sanctity of the market against the backdrop of an increasingly interconnected global economy.

©2024 Bloomberg L.P.