Korean financial regulator announces six-month ban on short sale trades

Useful Takeaways

A.      Covered short sale trades of all securities listed on the Korea Exchange (“KRX”) namely KOSPI, KOSDAQ, and KONEX markets are prohibited commencing March 16, 2020 and ending September 15, 2021 (“Relevant Period”) unless otherwise extended.

B.       Current limits on one-day stock buybacks by a KRX listed company has been eased during the Relevant Period.

C.       Minimum requirement for collateral coverage ratio applicable to stock companies has been lifted during the Relevant Period.

On March 13, 2020, the Financial Services Commission (“FSC”) announced a temporary ban on covered short selling, amid growing market instability. Naked short selling is already prohibited under the existing rules. This temporary ban will have the effect of prohibiting covered short selling of all types of securities listed on the KRX.

The FSC implemented market stabilization measures namely (i) a ban on covered short selling, (ii) easing of stock buyback limits and (iii) lifting the minimum collateral coverage ratio applicable to stock companies during the Relevant Period.

Covered short sale trades of all shares listed on the KRX are now prohibited. The FSC is authorized and is utilizing its powers under the Financial Investment Services and Capital Markets Act and its Enforcement Decree. This is the third time in Korea’s history where bans have been imposed on short selling of all types of securities listed on the KRX, the last occasion being in 2011 during the then global economic downturn.

During the Relevant Period, current limits on one-day stock buybacks by a listed company of its own stock will be eased. KRX listed companies are now able to repurchase their own shares (within the amount of retained earnings as of the end of the most recent financial year), up to the total number of shares that have been reported to the regulatory authority and the KRX. Currently, if it is directly acquired, KRX listed companies may in one day only purchase up to the lesser of (i) 10% of the treasury shares reported to the regulatory authority to buy-back or (ii) 25% of daily trading volume over 30-day period immediately prior to board approval of buyback. If acquired through a trust then, 1% of its total issued and outstanding shares. Furthermore, FSC has temporarily removed the minimum requirement for collateral coverage ratio applicable to stock companies.

In spite of the newly imposed ban on covered short selling, investors can continue to execute transactions outside the KRX (without involving physical delivery of the listed securities through the KRX) which may have the same or similar economic consequences as short selling. For example, investors may take a short exposure in the Korean market provided that it is done synthetically and no securities are delivered to the buyer. This also means that, as long as the short selling is synthetic, investors’ long positions will not be impacted or restricted and therefore can be unwound during the Relevant Period.

The Korean stock market recently saw unprecedented measures being taken, i.e. activation of a sidecar and a circuit breaker. It would be prudent for investors to closely monitor market trends and potential additional actions taken by the FSC.