A South Korea-based brokerage firm has been fined billions of won for allegedly allowing global investment banks (IBs) to short sell stocks without borrowing, ratcheting up tension in the Korean securities industry. This is because although the sanctions were imposed on the foreign-affiliated securities firm in Korea, any Korean securities firm that receives orders from overseas customers can be subject to illegal short selling sanctions.
Last week, the Securities and Futures Commission under the Financial Services Commission (FSC) voted to impose a total of 26.5 billion won (US$20.5 million) in fines on two multinational investment banks, BNP Paribas Hong Kong and HSBC Hong Kong and Seoul-based BNP Paribas Securities, an affiliate of BNP Paribas, according to financial authorities on Dec. 26.
Of special note is that fines in the billions of won were imposed not only on the global IBs that placed illegal short-selling orders, but also on BNP Paribas Securities, which received the orders from BNP Paribas. A custodian brokerage firm is obligated to check whether or not an order is a short-selling order, and if so, whether or not it holds borrowed shares, but BNP Paribas Securities failed to do so. The total fines for the two foreign IBs are said to be around 20 billion won, and the fine for BNP Paribas Securities 6 to 7 billion won.
“In the process of sharing the short-selling position and balance sheet details of an ordering company on a daily basis and checking the company’s settlement availability, a shortage of the balance occurred continuously, but BNP Paribas Securities neither identified the cause nor took preventive measures,” the Securities and Exchange Commission said. HSBC Securities Seoul, HSBC’s custodian brokerage firm, was not sanctioned as it was deemed to have fulfilled its verification obligations.
This was the first time that a securities firm in Korea was sanctioned for failing to confirm stock borrowing for short selling. Under the Capital Markets Act, an orderer must borrow stocks before short selling. In Korea, borrowing-free short selling is illegal, so obligations fall on both sides.
Under the current system, if a securities company does not confirm stock borrowing, it is sufficiently possible to short sell without borrowing, such as borrowing and filling stocks only until a settlement date (T+2). In Korea, it is illegal to place a short-selling order without borrowing stocks. But if there is no payment default, it is difficult for supervisory authorities to catch it without a report from the securities company. The large-scale borrowing-free short selling of the two global IBs caught this time was also a common practice until the Financial Supervisory Service began to thoroughly look into transactions one by one.
The sanctions are expected to speed up financial regulators’ inspections of custodian brokerage firms, but there are also concerns in the stock industry. The speed of transactions is also a factor, and the reality is that it is difficult to check every single stock holding. “For every sell order, it seems virtually impossible to verify whether sellers own stocks or not,” said one financial investment industry insider. “Speed is crucial when trading in microseconds and it is surely burdensome to hold brokerage firms accountable for simply brokering stock trades.”
However, the financial regulators say they are trying to distinguish between simple mistakes and systemically turning a blind eye to short selling without feeling guilty.