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Korean regulators propose changes to options trading rules


The Financial Services Commission of Korea (FSC) has announced plans to revise a number of rules pertaining to options and stock trading on the Korea Exchange (KRX), in the wake of a recent stock market dip attributed to large-volume program selling just before the close of a trading day. Eui Jong Chung of Bae, Kim & Lee, outlines some of the key changes.
The plans, to be defined further in the coming months, include tighter margin deposit requirements and daily order volume limits for institutional investors, and a change to the “random end” system for extending closing price determination after the regular market close.
In announcing the plans on December 7, the FSC cited the “shock” to the stock market on November 11, the maturity date of exchange-listed options, when heavy last-second program selling of KOSPI 200 shares led to sharp stock price declines. On that day, the FSC noted, asset management firms and brokers involved in settlement of the options saw losses totalling around US$800 million. The FSC’s stated aim now is, among other things, to augment risk management in relation to derivatives settlements.
Key measures outlined by the FSC are as follows:

● Current rules allowing post-trade deposit of margins by “qualified institutional buyers” (QIBs) will be tightened; further, based on a grading system, QIBs that fall below a certain threshold will be subject to pre-trade margin deposit requirements. The FSC has not yet provided further specifics in this regard.

● Each QIB will be subject to a limit on options orders, per day, based on the total margin amounts it has deposited with brokers.

● The existing “random end” mechanism will be modified, to further buffer against drops in stock prices just prior to market close: When the provisional closing price of a KRX issue deviates from indicative prices at 2.50 pm (rather than the current 2.55 pm) by more than a certain percentage (currently +/-5 percent), the deadline for bids will be subject to extension for up to an additional five minutes.

● Stricter enforcement measures will be adopted, for failure by KRX member companies to abide by the advance reporting deadline (2.45 pm) for program trades.

● The FSC is weighing limits on option positions maintained per investor, whereby options trading would be subject to the same type of limits that currently apply only to futures.

● New reporting requirements may be adopted for the reporting of derivatives positions exceeding to-be-defined thresholds.

The FSC is to review and discuss these plans in further detail with a variety of institutions and parties concerned. Changes to the relevant regulations will be adopted and implemented in stages during the coming weeks and months.
The FSC says its review of the options market is ongoing. Possibly, the FSC may consider further restrictions or rule changes in this regard, relating to limits on derivatives dealing by securities firms and asset management companies, the post-trade margin deposit regime and other aspects of the market. In addition to the restrictions outlined above, the FSC contemplates various enhancements in the supervision of options trading, such as requiring institutional investors to set up an internal system for real-time monitoring of risk-aggravating trading patterns.
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