Golden Age or Crisis Era? South Korea's Central Bank Set to Hike Rates, Brokerages to Raise Margin Requirements by 5x

Original｜Odaily Planet Daily (@OdailyChina)

Author｜Wenser (@wenser 2010 )

Who would have thought that before the KOSPI index hits a new high, the Bank of Korea might raise interest rates first!

According to foreign media sources, a source revealed that the market widely expects the Bank of Korea to raise the benchmark interest rate by 25 basis points to 2.75% at its meeting tomorrow; if confirmed, this would be South Korea's first rate hike since January 2023, marking a gap of about three and a half years. Some bond market experts even predict further rate hikes this year, with the benchmark rate reaching 3.00% by year-end and rising to 3.25% in the first half of next year.

As a result, despite a sharp rebound in the KOSPI index today, market panic has been triggered to some extent. Additionally, due to significant volatility in ETFs tracking stocks like SK Hynix and Samsung Electronics, South Korean brokerages are planning to raise the minimum margin requirement for single-stock leveraged ETF investments by five times.

Just a month ago, South Korean girls were cheering the stock market rally, exclaiming the arrival of a "golden age for humanity." Now, a month later, is the South Korean market heading into a crisis era due to tightening liquidity and higher entry barriers?

South Korea's Stock Market Under Comprehensive Scrutiny: From the President to Brokerages, from the Central Bank to Financial Regulators

The consecutive dramatic surges and crashes have driven South Koreans, often dubbed "a nation leveraging itself," into a frenzy. On July 13, an incident occurred in Busan where an investment KOL was stabbed by an emotionally driven fan who had lost money trading.

This extreme speculative frenzy has sparked widespread attention and debate across South Korean society, from President Lee Jae-myung to Korea Financial Investment Association Chairman Hwang Seong-yeop and CEOs of major asset management firms; from the central bank to financial regulators, everyone is focused on "stocks," "securities," and "financial markets."

South Korean President Lee Jae-myung: The Market Needs Time to Stabilize After a Rapid Rally

Today, during a policy meeting with senior government officials in Seoul, South Korean President Lee Jae-myung stated: "The domestic stock market is currently quite unstable. Since the market has experienced an unprecedented sharp rise in such a short period, it will require time and a certain degree of volatility to stabilize."

Acknowledging the controversy surrounding leveraged ETFs, Lee confirmed the issues and urged the Financial Supervisory Service and Korea Exchange to promptly address them and formulate follow-up measures.

Market analysts expect regulators to intervene to curb the impact of such high-risk products on market stability, which may include raising the minimum margin requirements for leveraged ETF investments. South Korea's main opposition party, the People Power Party, on Tuesday accused the Lee administration of promoting ambitious stock market goals while neglecting the accumulating leverage risks, thereby encouraging excessive risk-taking.

Previously, driven by the global AI industry and semiconductor boom, the South Korean government unveiled an "800 trillion won chip plant investment plan" and plans to invest at least 30 trillion won in the chip sector over the next 15 years. Just half a month later, circuit breakers were triggered on the KOSPI index, involving stocks like SK Hynix and Samsung, dimming the "semiconductor glory" that the nation once took immense pride in.

However, from a market perspective, sharp rallies are often followed by sharp declines. The government's push for industrial development and long-term construction is a natural step, but during this process, who bears the cost and who reaps the rewards remains to be seen.

South Korean Brokerages: Proposing to Raise Minimum Margin for Single-Stock Leveraged ETFs

According to a report by The Korea Herald, South Korea's brokerage industry has agreed to tighten investor protection rules for single-stock leveraged ETFs.

On Tuesday (July 14), the Korea Financial Investment Association convened an emergency meeting with CEOs of major brokerages to assess the market situation for leveraged ETFs tracking Samsung Electronics and SK Hynix, and to discuss countermeasures. Participants agreed in principle to raise the minimum margin requirement to curb excessive leverage usage by retail investors. One proposal under discussion involves increasing the minimum margin threshold from 10 million won (Odaily Planet Daily note: approximately $6,714) to 50 million won (Odaily Planet Daily note: approximately $33,570).

Institutions also agreed to provide more targeted risk warnings based on investors' age and portfolio composition, and to enhance investor education to help them better understand the structure and risks of these products. Additionally, the industry agreed to more evenly distribute rebalancing and hedging activities across the trading session to reduce market impact from concentrated buying and selling near the close.

Bank of Korea: Potential 25 Basis Point Rate Hike on Thursday, Tightening Cycle Approaching

According to a BigGo Finance report, financial sources reveal that the market broadly expects the Bank of Korea to raise the benchmark interest rate by 25 basis points, from 2.50% to 2.75%, at its meeting on Thursday. This would be the first rate hike since January 2023, a gap of about three and a half years, and may signal the start of a tightening cycle.

Bond market experts predict further rate hikes within the year, with the benchmark rate reaching 3.00% by year-end and rising to 3.25% in the first half of next year. This means borrowers should prepare for a rising interest rate environment lasting at least a year.

A central bank rate hike itself signals an effort to control market liquidity. This implies that—

• Margin loan rates rise, directly increasing the cost of loan-financed investments;
• The holding costs of existing leveraged capital surge, potentially forcing investors to sell off some stocks to raise liquidity;
• Higher capital costs further impact leveraged trading, leading to a contraction in new leveraged capital;

During the previous South Korean rate hike cycle from August 2021 to January 2023, the KOSPI index initially peaked near 3,000 points before falling to below 2,300 points, a decline of nearly 25%. Now, over the past year, the KOSPI index's low point was around 3,080, but its high has surged to 9,385 points, a cumulative gain of over 204%. According to JPMorgan data, the KOSPI has outperformed major global indices with a 109% gain year-to-date (compared to the S&P 500's 11% rise over the same period).

However, as mentioned earlier, the major components of single leveraged ETFs—Samsung Electronics and SK Hynix—together account for roughly 43% to 50% of the KOSPI weight. This "bull run" was never a broad-based rally but rather a malnourished, false prosperity.

On the other side, retail investors are facing mounting pressure from both the central bank and leveraged assets.

Retail Investors Under Pressure: Foreign Investors Sell Over $110 Billion in Assets This Year, Korean Retail Investors Bear the Brunt

According to Goldman Sachs data, foreign investors have net sold $110 billion in assets in the South Korean financial market this year, more than five times the previous peak of $22 billion in 2021. In June alone, they sold $31 billion, a record monthly high.

On the flip side, South Korean retail investors are accelerating their buying: after purchasing 42.4 trillion won in June, they have net bought 13.2 trillion won in KOSPI stocks this month as of July 14. As of July 14, the outstanding margin loan balance for retail investors investing in KOSPI stocks stood at 28 trillion won, having hit an all-time high of 29.8 trillion won on June 24.

These retail investors, primarily relying on margin trading and leveraged funds, are also facing capital constraints.

Data released by the Financial Services Commission and Financial Supervisory Service shows that as of the end of June, stock loan balances in the online investment-related financial industry stood at 898.3 billion won, an increase of 374.5 billion won from the first half. Compared to 351.3 billion won at the end of last year, this represents a surge of 71.5% within six months.

In response, the Financial Supervisory Service will issue management targets to online investment finance companies, requiring that new monthly stock loan volumes not exceed 30% of the previous month's newly issued related loans. This new management measure will take effect on August 16. Additionally, to prevent excessive concentration of stock loan business by online investment finance companies leading to risk accumulation, regulators stipulate that the upper limit for stock loans to a single borrower should, in principle, not exceed 1 billion won. However, companies can receive exemptions if they manage to keep their month-end stock loan balance from July onwards within the level recorded at the end of June.

In summary, regulators are controlling retail investors' leverage levels from the funding source to prevent further fuel for the stock market bubble.

In conclusion, South Korean government agencies are implementing four measures—"shutting the gate, limiting loans, raising the bar, and cooling the heat"—to address risks associated with the domestic stock market's sharp fluctuations, structural imbalances, and accelerating bubble.

As for whether the rate hike will sound the first whistle for a downward trend in the stock market this year, we will have to observe the market's reaction tomorrow.