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2019 Jan/10
Comparative analysis of the margin trading system between the Korean and Japanese stock markets Survey Papers 19-01 PDF
Stock trading in the domestic stock market has developed mainly focusing on cash trading, but margin trading has been also steadily increasing. The most important role of stock margin trading will be to increase the market liquidity. This is because frequent trading is likely to ensure the credibility of the prices observed in the market. Market liquidity can give the confidence in the prices by repeatedly providing opportunities for the information on companies to be reflected in the price.

For a long time, margin trading has developed mainly for margin trading long. On the other hand, despite the same economic functioning, margin trading short was very sluggish. Margin trading is a system that can work symmetrically with respect to rises and falls in the stock price, but there exists a high level of asymmetry in the usage of long and short.
It is also noteworthy that the margin trading short has a close relationship with short selling by individual investors. For institutional investors, there are no significant constraints on stock borrowing. However, since individual investors are relatively lower in the credit grade, it is almost impossible to borrow stocks. The margin trading shos virtually a unique borrowing vehicle available to retail investors. This means that if the margin trading short is active, individual investors' accessibility to short sale can be greatly improved. Thus the margin trading short may have a significant impact on individual investors' short selling activities.
Margin trading is divided into the in-house financing in which securities companies use their own funds or securities as lending resources and the KSFC financing in which funds or securities are borrowed from KSFC. KSFC financing is divided into the long and the short again. The operating structure of the long is more complicated than the short. This is because the funds for the long are homogeneous for all cases, whereas stocks for the short can be different case by case. Due to the characteristics of the short, the provision of loan resources is much more difficult for the short than for the long. If these structural differences are not sufficiently reflected in the design of the margin trading system, the symmetry of the long and the short will not be realized properly.

Japanese stock market has a system that can reliably supply the short services to individual investors. The credit problems on individual investors are solved through a centralized supply mechanism. A securities finance company acquires resources for the short by its own credit and provides them to securities companies for the retail services. The centralized supply mechanism is believed to systematically support the short selling activities of individual investors. It is also reported in the academia that this centralized approach significantly mitigated the short selling restrictions on individual investors.
Short selling in the domestic stock markets has been steadily increasing. Active investor groups in the short selling include institutional investors and foreign investors. The share of foreign investors in the short selling in Korea is overwhelmingly high and that of individual investors is extremely low. As of June 2018, the short interests amounted to 16.7 trillion won, a 60% increase over the two-year time period. The KOSPI and the KOSDAQ had short interests of KRW 12.7 trillion and KRW 4.0 trillion, respectively.

In the KOSPI and the KOSDAQ, 0.5% and 1.0% of total short selling are done by individual investors respectively. The sluggish short selling by individual investors seems to be due to the difficulty in the stock borrowing, which is essential for short selling. The only way for individual investors to borrow stocks is through the margin service provided by securities companies. Stocks that can be borrowed through the margin service are limited in terms of label and quantity. 
Short selling in Japanese stock market is quite active. As of 2017, proportion of the short selling in the Japanese stock market reached 38.7%. As compared with the fact that the proportion of short selling in the KOSPI is only 5.5% at the same time, we can see that the short selling in Japanese stock market is very active.

In order for the margin trading system to develop symmetrically both for the long and the short, it is necessary to add significant system improvement. The margin trading short is the only stock borrowing vehicle that individual investors can rely on. The following approaches can be considered for enhancing the accessibility to the short selling.

First, it is necessary to establish a centralized stock lender. The role of brokerage firms plays a large role in the stock lending. However, their role could be limited due to the difficulties in risk management. A centralized stock lending can be more useful when we consider the economies of scale.

There is also a need to increase utilization of the collaterals from the long and design alternative lending sources. Stocks that can be used as financing resources for the short are limited only to stocks explicitly agreed for lending by the margin long holders. It is crucial to find alternative ways to supply for lending. Stock borrowing in B2B market can be a primary consideration. If stock lenders can borrow stocks by their own credit and use the stocks as lending resources, it could help significantly in resolving the asymmetry of the margin trading system. We can also consider mechanisms to increase individual investors’ agreement by enhancing financial incentives and utilization of collateral through the standard terms of condition.