With the resumption of short selling in March approaching, the Financial Supervisory Service (FSS) announced the final proposal for the regulatory framework. It differentiated internal control standards based on the size of corporations using short selling strategies and specified the items that securities firms must check to prevent illegal short selling.
On the 19th, the FSS announced the final proposal for the unified guidelines on short selling, which is outlined in this context. The advance notice period for the implementation rules is until the 31st of this month, with plans to complete the amendments in March.
According to the guidelines, both large (with a short selling balance of 0.01% or 1 billion won or more) and small short selling firms must comply with ▲ role distribution (clarifying roles and responsibilities of employees performing short selling) ▲ monitoring (compliance monitoring of short selling regulations by a third department such as the audit department) ▲ self-measures (actions such as sanctions against employees upon discovering violations) ▲ data retention (keeping detailed records of internal control activities for 5 years).
Large corporations must also establish a balance management system within their organization. This system must calculate real-time balances by stock, and it must block orders that exceed the balance in real time. Additionally, they must have control mechanisms in place when manually correcting data. Unauthorized individuals cannot access the system, and if an error occurs, short selling must be halted.
However, small short selling corporations only need to establish rules for short selling operations. They must check compliance with legal requirements before orders and verify them afterward. They also need to record and manage order information when placing orders. They must calculate the available selling balance before and after orders and swiftly reflect over-the-counter transactions in this balance. A procedure to block orders exceeding the balance must also be established.
Corporations that do not intend to engage in short selling are not obligated to establish computer systems or submit balance information to the Korea Exchange.
One of the main points of the guidelines is to specify the inspection items and methods for the securities firms entrusted with short selling. The inspection items include the presence of internal control standards, clarity of role distribution, and compliance with requirements and operating conditions of the balance management system within the organization.
While it is generally the principle that securities firms conduct direct inspections, indirect inspections are allowed if the need for confidentiality regarding the management of a short selling corporation is recognized. Indirect inspections refer to the method where the short selling corporation conducts its own inspection and the entrusted securities firm reviews its appropriateness.
The entrusted securities firm must fulfill its obligation to verify before accepting the initial short selling order. They must conduct inspections periodically at least once a year. After the verification is completed, they must report the inspection results to the FSS within a month.
An administrative procedure has also been established to verify the existence of entities subject to short selling registration numbers. To track illegal short selling, the FSS will issue registration numbers to large short selling trading corporations. Market makers (MM) and liquidity providers (LP) must separate accounts for transactions as MM and LP. Registration numbers will also be assigned here. For investment and trust, numbers will be issued per investor asset.
However, if investors notify the securities firm that they will not submit short selling orders for their assets, they do not need to receive a registration number. The same applies when the securities firm has completed the necessary computer measures to ensure that short selling orders are not submitted for the relevant investor assets.
Large short selling trading corporations must specify the target information and submission deadlines required to be submitted to the Korea Exchange. This includes all balances and transaction history for each stock held by the corporation. Balance information must be submitted within two business days.
In this regard, the Korea Exchange has been granted the authority to require data submission to the market surveillance committee to verify the accuracy of information submitted to the Illegal Short Selling Central Blocking System (NSDS). Additionally, the implementation rules have been revised to impose an obligation on securities firms to verify short selling registration numbers and input registration numbers when submitting quotes.
The FSS will hold an explanatory session this month to enhance understanding of the obligation to verify compliance with measures to prevent naked short selling by entrusted securities firms. Next month, they plan to host an open discussion with investors. In March, there will be a computer systems connection ceremony and demonstration between corporations that build systems to detect naked short selling and the Korea Exchange.
The FSS noted, “By formalizing the contents of internal control standards in the implementation rules, we expect that regulatory clarity will be improved,” adding that “with the establishment of detailed standards for operating the NSDS, the effectiveness of the system for detecting illegal short selling will also be increased.”