South Korea’s Market Rout May Not Be Over as Analysts Warn ETF Rules Won’t Calm Turmoil
South Korean regulators have announced a series of new rules for single-stock leveraged exchange-traded funds as the market’s relentless, roller-coaster decline puts pressure on authorities. The measures are intended to curb volatility and protect investors, but analysts warn they may not be enough to calm the market’s sharp swings. After surging like a rocket and then plunging like an avalanche, South Korea’s stock market has undergone a dramatic reversal over the past month, leaving local investors in deep distress. Single-stock leveraged ETFs have been criticized for amplifying volatility and adding to the broader market’s decline. As the once-popular trade reversed, South Korean stocks fell about 40% from the record high reached last month. The market capitalization of KOSPI constituent stocks evaporated by USD 2 trillion. Retail investors who borrowed money to chase the rally suffered the heaviest losses. The situation has put the South Korean government under substantial pressure. The government had previously helped propel the market higher, but as stocks collapsed, some angry investors even placed funeral wreaths outside the National Assembly to express their dissatisfaction. The new leveraged-ETF rules may not be enough to stop the turmoil. After South Korean stocks hit circuit breakers for two consecutive days on Wednesday, the governor of the Bank of Korea and heads of financial regulatory agencies held an emergency meeting that evening to discuss a response. Regulators said they would limit individuals’ positions in any single leveraged ETF and raise trading costs for those funds. The meeting decided to implement aggregate controls, including individual investment limits. Authorities gave as an example a rule that would cap an individual investor’s position in leveraged ETFs at no more than 20% of the investor’s total financial assets. South Korean regulators also said they would extend to the stock market an “excessive quotation surcharge” currently used only in the futures market. The system charges a fee resembling a penalty for placing large orders without an actual intention to execute them and then canceling those orders. Authorities had already decided to suspend the listing of new single-stock leveraged ETFs. Starting on the 31st, individual investors opening accounts or adding to positions in single-stock leveraged products will also be required to keep KRW 30 million in cash in their accounts, up from KRW 10 million. Market participants said, however, that the current rules do not directly limit the amount of leverage in ETFs, unlike regulations in Hong Kong. As long as buyers remain eager to get rich quickly, it will be difficult to reduce the impact of these products, they said. As background, Hong Kong’s Securities and Futures Commission revised and issued a circular on listed structured funds last Friday, the 24th, introducing a flexible leverage structure. The maximum leverage for leveraged products cannot exceed the existing 2x limit, or -2x for inverse products. Fund managers can, however, adjust leverage dynamically each day according to market conditions, with a minimum of 1.1x, or -1.1x for inverse products. Analysts said the flexible leverage mechanism could reduce market shocks from passive rebalancing by allowing managers to lower leverage proactively, helping to mitigate systemic risk. Kim Jin-wook, an economist for Citigroup in South Korea, said: “These measures will help ease volatility in the South Korean stock market, but the effect would be better if liquidity-support tools such as a market-stabilization fund could be introduced.” The head of research at a Seoul brokerage said South Korea’s latest regulatory measures were unlikely to be effective because the investment-limit plan was announced too hastily and lacked careful consideration. He also said Hong Kong’s rules had effectively reduced forced-liquidation selling when markets came under pressure, helping to lower volatility. He added that the ETF investment cap would not affect existing investors because they would not be forced to reduce their positions. South Korea’s new rules also cannot constrain similar leveraged products listed in New York and Hong Kong, meaning market turbulence may continue. After two consecutive days of steep losses, South Korean stocks stabilized somewhat on Thursday but failed to reverse the decline. The KOSPI index closed down 1.23% at 5,593.56 points. South Korea’s stock market is on course for its largest monthly decline on record in July. The rout has unfolded even as the country’s “storage giants,” Samsung Electronics and SK hynix, reported strong earnings. The two companies together reported quarterly profits of KRW 150 trillion, or about USD 100 billion, this week.
After surging like a rocket and then plunging like an avalanche, South Korea’s stock market has undergone a dramatic reversal over the past month, leaving local investors in deep distress. Single-stock leveraged ETFs have been criticized for amplifying volatility and adding to the broader market’s decline.
As the once-popular trade reversed, South Korean stocks fell about 40% from the record high reached last month. The market capitalization of KOSPI constituent stocks evaporated by USD 2 trillion. Retail investors who borrowed money to chase the rally suffered the heaviest losses.
The situation has put the South Korean government under substantial pressure. The government had previously helped propel the market higher, but as stocks collapsed, some angry investors even placed funeral wreaths outside the National Assembly to express their dissatisfaction.
The new leveraged-ETF rules may not be enough to stop the turmoil. After South Korean stocks hit circuit breakers for two consecutive days on Wednesday, the governor of the Bank of Korea and heads of financial regulatory agencies held an emergency meeting that evening to discuss a response. Regulators said they would limit individuals’ positions in any single leveraged ETF and raise trading costs for those funds.
The meeting decided to implement aggregate controls, including individual investment limits. Authorities gave as an example a rule that would cap an individual investor’s position in leveraged ETFs at no more than 20% of the investor’s total financial assets.
South Korean regulators also said they would extend to the stock market an “excessive quotation surcharge” currently used only in the futures market. The system charges a fee resembling a penalty for placing large orders without an actual intention to execute them and then canceling those orders.
Authorities had already decided to suspend the listing of new single-stock leveraged ETFs. Starting on the 31st, individual investors opening accounts or adding to positions in single-stock leveraged products will also be required to keep KRW 30 million in cash in their accounts, up from KRW 10 million.
Market participants said, however, that the current rules do not directly limit the amount of leverage in ETFs, unlike regulations in Hong Kong. As long as buyers remain eager to get rich quickly, it will be difficult to reduce the impact of these products, they said.
As background, Hong Kong’s Securities and Futures Commission revised and issued a circular on listed structured funds last Friday, the 24th, introducing a flexible leverage structure. The maximum leverage for leveraged products cannot exceed the existing 2x limit, or -2x for inverse products. Fund managers can, however, adjust leverage dynamically each day according to market conditions, with a minimum of 1.1x, or -1.1x for inverse products.
Analysts said the flexible leverage mechanism could reduce market shocks from passive rebalancing by allowing managers to lower leverage proactively, helping to mitigate systemic risk.
Kim Jin-wook, an economist for Citigroup in South Korea, said: “These measures will help ease volatility in the South Korean stock market, but the effect would be better if liquidity-support tools such as a market-stabilization fund could be introduced.”
The head of research at a Seoul brokerage said South Korea’s latest regulatory measures were unlikely to be effective because the investment-limit plan was announced too hastily and lacked careful consideration. He also said Hong Kong’s rules had effectively reduced forced-liquidation selling when markets came under pressure, helping to lower volatility.
He added that the ETF investment cap would not affect existing investors because they would not be forced to reduce their positions. South Korea’s new rules also cannot constrain similar leveraged products listed in New York and Hong Kong, meaning market turbulence may continue.
After two consecutive days of steep losses, South Korean stocks stabilized somewhat on Thursday but failed to reverse the decline. The KOSPI index closed down 1.23% at 5,593.56 points.
South Korea’s stock market is on course for its largest monthly decline on record in July. The rout has unfolded even as the country’s “storage giants,” Samsung Electronics and SK hynix, reported strong earnings. The two companies together reported quarterly profits of KRW 150 trillion, or about USD 100 billion, this week.