South Korea Weighs Emergency Power to Cut Leverage on Single-Stock Products
South Korean financial regulators are reportedly moving to introduce an “emergency action authority” that would allow them to quickly reduce the leverage multiples of single-stock leveraged products during periods of market stress. These products are seen as one of the main factors behind the market’s sharp volatility. The regulators are also studying additional restrictions, including a cap on the amount investors can allocate to leveraged products and a further increase in minimum initial-margin requirements. The Financial Services Commission, or FSC, is reportedly working with the Financial Supervisory Service, or FSS, to draft amendments to the Financial Investment Business and Capital Markets Act. The changes would establish a legal basis for taking market-stabilization measures in emergencies. The central proposal would allow regulators to temporarily adjust the leverage multiple of single-stock leveraged ETFs. South Korean single-stock leveraged products currently aim to deliver twice the underlying return. Under the proposed emergency authority, the multiple could be reduced to 1.5 times or 1 time if regulators determine that doing so is necessary to protect investors. Although South Korea has already announced measures targeting single-stock leveraged products to curb stock-market volatility, some analysts say those steps may not be enough to calm the market’s sharp swings. Market participants note that current regulations do not directly limit the size of ETF leverage. FSC Chairman Lee Eok-won said at a full meeting of the National Assembly’s Political Affairs Committee on the 29th that reducing the current 2-times leverage multiple “appears likely to be effective in reducing market volatility.” He added that regulators would simultaneously examine ways to protect investors while developing the legislation, including through mechanisms such as meetings of ETF beneficiaries. Hong Kong’s precedent of using flexible leverage multiples for leveraged products is providing a reference for South Korean regulators. On July 24, the Hong Kong Securities and Futures Commission revised and published a circular on listed structured funds, introducing a flexible leverage structure. Under the framework, a leveraged product’s maximum multiple cannot exceed the existing 2 times, or -2 times for inverse products, while fund managers may adjust the multiple daily according to market conditions. The minimum is 1.1 times, or -1.1 times for inverse products. Under South Korea’s current Financial Investment Business and Capital Markets Act, changing a leverage multiple is not easy. Because the multiple directly affects investor returns, a resolution by a meeting of beneficiaries would likely be required. One requirement is approval by more than half of the beneficiaries present, making it difficult for regulators to respond quickly to rapidly changing market conditions. Regulators are therefore considering a plan that would allow them to temporarily adjust leverage multiples for a specified period during emergency market conditions without first holding a meeting of beneficiaries. A cap would apply during the emergency period, and the leverage multiple could only be reduced below its existing level. That is the main proposal currently under discussion. At the same time, regulators are considering a leverage-investment limit and mandatory simulated trading. Under the core proposal, funds used by an investor for leveraged products could not exceed 20% of the investor’s total investment amount. The minimum initial-margin requirement for investing in leveraged ETFs could also be raised again. Regulators increased the requirement from KRW 10 million to KRW 30 million on July 31, but said they could tighten it further depending on market conditions. On Monday, South Korean stocks extended their volatile trading. After a sharp rebound the previous Friday, the market fell heavily. As of press time, the KOSPI was down nearly 5%, Samsung shares were down more than 8%, and SK hynix shares were down more than 7%.
The regulators are also studying additional restrictions, including a cap on the amount investors can allocate to leveraged products and a further increase in minimum initial-margin requirements.
The Financial Services Commission, or FSC, is reportedly working with the Financial Supervisory Service, or FSS, to draft amendments to the Financial Investment Business and Capital Markets Act. The changes would establish a legal basis for taking market-stabilization measures in emergencies.
The central proposal would allow regulators to temporarily adjust the leverage multiple of single-stock leveraged ETFs. South Korean single-stock leveraged products currently aim to deliver twice the underlying return. Under the proposed emergency authority, the multiple could be reduced to 1.5 times or 1 time if regulators determine that doing so is necessary to protect investors.
Although South Korea has already announced measures targeting single-stock leveraged products to curb stock-market volatility, some analysts say those steps may not be enough to calm the market’s sharp swings. Market participants note that current regulations do not directly limit the size of ETF leverage.
FSC Chairman Lee Eok-won said at a full meeting of the National Assembly’s Political Affairs Committee on the 29th that reducing the current 2-times leverage multiple “appears likely to be effective in reducing market volatility.” He added that regulators would simultaneously examine ways to protect investors while developing the legislation, including through mechanisms such as meetings of ETF beneficiaries.
Hong Kong’s precedent of using flexible leverage multiples for leveraged products is providing a reference for South Korean regulators. On July 24, the Hong Kong Securities and Futures Commission revised and published a circular on listed structured funds, introducing a flexible leverage structure. Under the framework, a leveraged product’s maximum multiple cannot exceed the existing 2 times, or -2 times for inverse products, while fund managers may adjust the multiple daily according to market conditions. The minimum is 1.1 times, or -1.1 times for inverse products.
Under South Korea’s current Financial Investment Business and Capital Markets Act, changing a leverage multiple is not easy. Because the multiple directly affects investor returns, a resolution by a meeting of beneficiaries would likely be required. One requirement is approval by more than half of the beneficiaries present, making it difficult for regulators to respond quickly to rapidly changing market conditions.
Regulators are therefore considering a plan that would allow them to temporarily adjust leverage multiples for a specified period during emergency market conditions without first holding a meeting of beneficiaries. A cap would apply during the emergency period, and the leverage multiple could only be reduced below its existing level. That is the main proposal currently under discussion.
At the same time, regulators are considering a leverage-investment limit and mandatory simulated trading. Under the core proposal, funds used by an investor for leveraged products could not exceed 20% of the investor’s total investment amount.
The minimum initial-margin requirement for investing in leveraged ETFs could also be raised again. Regulators increased the requirement from KRW 10 million to KRW 30 million on July 31, but said they could tighten it further depending on market conditions.
On Monday, South Korean stocks extended their volatile trading. After a sharp rebound the previous Friday, the market fell heavily. As of press time, the KOSPI was down nearly 5%, Samsung shares were down more than 8%, and SK hynix shares were down more than 7%.