Regulator expected to inspect Korea Exchange to eradicate illegal shorting

Korea Exchange (KRX) Chairman Sohn Byung-doo delivers a speech during his inauguration ceremony at the bourse operator's headquarters in Busan, Monday. / Courtesy of KRX

By Park Jae-hyuk

The Financial Supervisory Service (FSS) is expected to conduct a comprehensive inspection of the Korea Exchange (KRX) early next year to find out whether it has offered preferential treatment for brokerages to conduct illegal short-selling, industry sources said, Monday.

The financial watchdog has not conducted a comprehensive inspection of the bourse operator since 2010, although there were several cursory inspections over the past decade.

The envisioned measure comes after retail investors alleged the KRX concealed unlawful acts by foreign and domestic securities firms, including naked shorting, which refers to the practice of conducting short-selling without actually borrowing stocks. Short-selling refers to a method in which an investor sells borrowed shares in the belief that the price will fall and they can buy the shares back at a discount, keeping the profits and returning the borrowed shares.

Regarding the timing of the inspection, an FSS official said the Financial Services Commission's (FSC) approval is needed to inspect the KRX. The FSC was unavailable for comment on the issue. On a related note, FSS Governor Yoon Suk-heun also said in a National Assembly audit in October that he felt it was necessary to conduct a comprehensive inspection of the KRX for various reasons.

In October, the KRX conducted a special inspection of 22 brokerages here to scrutinize their transactions over the past three-and-a-half years. The 22 are designated as market makers, or liquidity providers, which are allowed to conduct short-selling as an exception, despite a temporary ban on the investment method.

After the inspection, the bourse operator announced it discovered several suspicious cases, but said most of them had resulted from technical errors.

“It is difficult to trust in the result of the inspection done by the KRX, whose shareholders are securities firms,” said Chung Eui-jung, the head of the Korea Stockholders Alliance comprised of 18,000 retail investors.

KRX Chairman Sohn Byung-doo, who started his first three-year term, Monday, said at his inauguration ceremony that he will reform the rules on short-selling and market makers to satisfy all market participants.

The financial authorities have already come up with various reforms to calm retail investors, before lifting the temporary ban on short-selling in March next year. The FSC said last week it will prohibit market makers from conducting short-selling on the Mini-KOSPI 200 Futures and Options and will shorten the interval of inspection for illegal short-selling to one month from six months. The financial regulator will also seek to enable retail investors here get better access to short-selling.

In addition, FSC Governor Eun Sung-soo met the Korea Stockholders Alliance leader, Dec. 10, to talk about plans to reform the rules on short-selling. However, retail investors are still unsatisfied with the proposed measures.

“Foreigners earned 100 trillion won from the Korean stock market last year, and the outflow of the national wealth will continue if short-selling is resumed,” Chung said. “If foreign investors try to cover their losses made this year, it is obvious there will be a collapse in the stock market next year.”