How to regulate single-stock leveraged ETFs? On Thursday, the entire market's eyes were on the Korean government's meeting

Original Author: Long Yue

Source: Wall Street CN

A financial product launched just one and a half months ago has thrown South Korea's top economic decision-makers into emergency mode.

South Korea's "F4" high-level coordination mechanism will convene a meeting this Thursday to discuss countermeasures regarding the impact of single-stock leveraged ETFs on the stock market. This marks the first time this issue has formally entered the highest-level economic coordination platform, jointly participated in by the Ministry of Economy and Finance, the Financial Services Commission (FSC), the Bank of Korea, and the Financial Supervisory Service (FSS).

The trigger for the event is clear: KOSPI plunged over 8% in a single day this Monday, triggering its seventh circuit breaker of the year. Market blame is squarely directed at single-stock leveraged ETFs. These products amplify the daily price movements of individual stocks, accelerating price deviations during volatile market conditions, creating an amplifying effect where they "boost gains when the market rises and exacerbate losses when it falls." Single-stock leveraged products were officially launched on May 27, allowing investors to place 2x bets on the price movements of Samsung Electronics and SK Hynix. The returns of these products are linked to multiples of the daily price change of the underlying asset. To achieve this return matching, the underlying assets must be bought or sold daily, further amplifying market volatility.

Prior to Thursday's meeting, South Korean securities companies and asset management firms had already planned to hold an industry meeting on Tuesday to discuss issues related to leveraged ETFs and overall market conditions, conducting a preliminary assessment for the government meeting.

Escalating Regulator Rhetoric, a Rare Utterance of 'Regret'

The regulatory stance has escalated from "concern" to "self-criticism," explicitly acknowledging a structural dilemma.

On July 13, FSS Governor Lee Bok-hyun presided over a closed-door meeting on Yeouido with representatives from 20 asset management companies. During the meeting, he frankly stated: "There are structural issues, making it unlikely to provide a clear answer." He further added, "Under the current circumstances, this issue cannot be resolved at once; it requires continuous monitoring, revision, and improvement." This reflects the deep-seated dilemma faced by financial authorities in proposing specific solutions.

Lee did not elaborate on the so-called "structural issues." External interpretations generally point to two key factors: First, retail investors have already net purchased nearly 10 trillion Korean Won of these products, making forced liquidation nearly impossible. Second, these products were only launched after joint revisions to enforcement decrees by the Presidential Office, the FSC, and the Korea Exchange, and forced delisting would undermine the legal credibility of the relevant regulations.

He also stated: "This does not seem to be a domain where a single individual can have the final say. The authorities (FSC) may also need to deliberate broadly. We (FSS) will do our best, but currently, we are in a position of absorbing criticism. Asset management companies should openly share their actual needs and institutional suggestions, which will become important references for policy decisions."

In a routine press conference on the 22nd of last month, FSS Governor Lee Bok-hyun stated bluntly: "Regarding the launch of single-stock leveraged ETFs, I regret not having done my utmost to prevent it." This phrasing is exceedingly rare in the context of South Korean financial regulation. However, the very next day after he made this statement, KOSPI plunged 10%. From the 22nd of last month to the 13th of this month, KOSPI's cumulative decline has exceeded 25%.

Earlier this month, he further stated that regulators are "seriously reviewing the unintended consequences that have emerged since these products were launched."

Deputy Prime Minister and Minister of Economy and Finance, Koo Yun-cheol, also commented at a National Assembly meeting last week, saying, "Given that multiple issues have been raised, consultations are currently underway regarding plans for remediation and minimizing related problems."

Presidential Chief of Staff for Policy, Kim Yong-beom, clearly stated in a press conference that the F4 meeting is in-depth researching the issue of single-stock leveraged ETFs exacerbating market volatility. "If remedial measures are deemed necessary, a decision will be made at the F4 market conditions review meeting."

Three Prongs of Approach: Raising Margins, Limiting Price Swings, Adjusting Leverage Caps

Ahead of Thursday's meeting, regulators have been simultaneously pursuing countermeasure research through multiple channels.

According to sources in South Korea's financial investment industry, financial authorities have formally requested asset management companies to submit specific improvement suggestions regarding market volatility potentially caused by single-stock leveraged ETFs. The authorities will compile industry opinions before initiating formal plan formulation.

Currently, potential measures under market discussion fall into three categories: raising margin requirements, limiting daily price fluctuation ranges, and adjusting the upper limit on leverage ratios.

The FSC will convene experts from major securities companies and asset management firms on the 14th to discuss supplementary measures for single-stock leveraged products. Specific proposals include increasing the minimum margin requirement (i.e., the capital threshold investors must pre-deposit in their accounts) and strengthening pre-investment education.

However, regulatory officials also acknowledge that the above plans "may only be temporary patches, rather than addressing the structural root causes of market volatility." This implies that even if a decision is reached at Thursday's meeting, subsequent policies may still face further adjustments.

Data Confirms the Impact: Circuit Breakers Hit a Historic Record

The contrast in market volatility before and after the launch of single-stock leveraged ETFs is alarming. According to statistics from NH Investment & Securities, in the 96 trading days before the product launch, the proportion of days where KOSPI's single-day change exceeded 3% was 27% (26 days). In the 33 trading days after the launch up to the 13th, this proportion soared to 52% (17 days). In comparison, the U.S. S&P 500 index has yet to see a single-day fluctuation of 3% this year.

Data from the Korea Exchange shows that as of the 13th, the securities market has triggered the "sidecar" (temporary trading halt mechanism, including 17 buy-side triggers and 18 sell-side triggers) 35 times this year. This is significantly higher than the mere 3 times recorded for the entire last year. Even before July has ended, it has already surpassed the historic record of 26 times set during the 2008 global financial crisis. The circuit breaker mechanism, which halts market trading entirely, has been triggered 7 times this year, exceeding half of the total 13 times it has been triggered since its introduction in 2000.

The Wall Street Journal also noted: "The volatility of the South Korean stock market is further amplified by leveraged products linked to Samsung Electronics and SK Hynix."

Product Launch One and a Half Months, Already Triggers Top-Level Intervention

It has been approximately one and a half months since single-stock leveraged ETFs were listed in South Korea, and regulatory pressure has rapidly escalated from the FSS level to the highest economic decision-making tier.

Kim Yong-beom pointed out at the press conference, "The related products have been operational for about one and a half months. The F4 will carefully evaluate their actual impact on the market."

Currently, market expectations are intensifying that these products will face stricter limitations. Tightening leverage ratios, raising investor entry thresholds, or other structural constraints are all within the scope of discussion. As the market continues to experience severe turbulence, criticism over the hasty launch of these products in less than five months is also mounting.

The future direction of policy will depend on the evaluation conclusions of South Korea's F4 meeting on Thursday.