HSBC, BNP Paribas to be fined for naked short sales in S.Korea

South Korea's Financial Supervisory Service (FSS) will fine the Hongkong and Shanghai Banking Corporation Ltd. (HSBC) and Bank BNP Paribas the largest-ever penalties for illegal short selling in the country's public stock market, The Korea Economic Daily learned on Sunday.

Two Hong Kong-based investment banks conducted illegal short sales worth a combined 56 billion won ($41.3 million), the FSS said on Oct. 15. It is the first time that the financial watchdog has confirmed global IBs’ intentional illegal short selling; most of the previous cases were hedge funds' mistakes, the FSS said.

Although the watchdog agency did not disclose the names of the two IBs, The Korea Economic Daily has learned that the banks are HSBC and BNP Paribas.

INTENTIONAL NAKED SHORT SALES

The FSS said one IB ordered 40 billion won in naked short selling of 101 listed stocks in Korea, including shares of mobile platform giant Kakao Corp., between September 2021 and May 2022. That bank is BNP Paribas, banking sources said.

Naked short selling, a practice that short-sells stocks without first making borrowing arrangements, is unlawful in Korea. The financial watchdog saw the number of such illegal cases increase from 14 in 2021 and 28 in 2022 to 30 during the January-September period of this year. 

Global IBs can make short-sale orders of Korean stocks when providing prime brokerage services to overseas institutional investors. BNP Paribas was found to have ordered short sales for its foreign investor clients, based on double counting of borrowed securities.

The day after the trade, the bank made it aware that the borrowed stocks were insufficient for settlement. But it did not take appropriate action at the time and postponed borrowing.

Another IB also ordered 16 billion won worth of short sales from August to December 2021. It ordered sales of nine companies' stocks, including Hotel Shilla, the FSS said. That bank is HSBC, according to banking sources. 

HSBC is understood to have made the short-sale orders based on the number of shares that could be borrowed in the future, not the number that had been confirmed for borrowing.

STRENGTHENED SCRUTINY

“We can’t assume that the global IBs made illegal short sales in Korea due to a lack of understanding of the local investment system,” said FSS Deputy Governor Kim Jungtae. “We recognize that the IBs have made the cases intentionally as they shorted stocks without borrowing over a long period,” he added.

The FSS does not appear to think the unlawful conduct had a significant effect on the Korean stock market.

"The proportion of short sales in the trading of each stock was not large, and the IBs had losses while short selling and liquidating some shares. Therefore it is difficult to conclude that the banks seriously affected the decline of the stock prices,” said an official from the FSS’ investigation unit.

“We see that the banks have ignored their illegal sales to earn brokerage fees from their institutional investors,” the official added.

The financial watchdog expects the IBs to be fined the largest penalty since Korea introduced a penalty system for naked short selling.

The largest financial penalty to date is 3.9 billion won, imposed on Austria-based Erste Asset Management GmbH in March. The firm ordered battery materials maker EcoPro HN Co. stocks worth 25.1 billion won that they hadn’t borrowed, and executed a 4.9 billion won transaction in August 2021.  

From January to September of this year, the FSS’ short selling investigation unit imposed a total of 10.7 billion won in fines on 30 financial services firms, 21 of which were foreign firms.

The amount fined for illegal short sales in Korea is increasing, rising from 700 million won in 2020 to 900 million won in 2021 and 3.2 billion won last year.

The financial watchdog said it will expand its probe to include alleged naked short sales by other global IBs.

(Updated with the names of the investment banks)

Write to Han-Gyeol Seon and Sang Hoon Sung at always@hankyung.com

Jihyun Kim edited this article.