Amid mounting criticism that single-stock leverage exchange-traded funds (ETFs) tied to Samsung Electronics (005930.KS) and SK hynix (000660.KS) are fueling stock market volatility, President Lee Jae-myung has ordered supplementary measures, launching a full-scale review of the system less than two months after the products were listed. At a Blue House briefing on the 15th, President Lee instructed Korea Exchange (KRX) Chairman Chung Eun-bo and Financial Supervisory Service (FSS) Governor Lee Chan-jin to "swiftly prepare sound supplementary measures" regarding single-stock leverage ETFs.
Financial authorities argue that hedge trading generated in the management of single-stock leverage ETFs may increase spot market volatility, and that supplementary measures are needed to protect investors and stabilize the market, given that trading volume is concentrated in a few products.
The financial investment industry, by contrast, says that while single-stock leverage ETFs may have amplified market volatility somewhat, they are difficult to view as the main cause of market instability. The industry also agrees on the need for investor protection but raises concerns that excessive regulation could repeat the past pattern of shrinking Korea's domestic derivatives market.
The derivatives market regulations enacted after 2012 are the first case cited. Korea's domestic derivatives market became the world's largest by trading volume after individual investors flooded in following a 2001 reduction of the basic deposit requirement from 30 million won to 5 million won. However, when financial authorities raised the contract multiplier fivefold in 2012 under the banner of investor protection and lifted the basic deposit to between 30 million and 50 million won in 2014, the market began to contract. Trading volume plunged, and by 2016 the market had fallen out of the world's top 10. At the time, the side effects of the regulations were so significant that industry voices went as far as to say the government had "burned down the thatched house trying to catch a bedbug." The Korea Exchange subsequently introduced small-value investment products such as mini KOSPI 200 futures and options in succession to revive the shrunken market, but failed to recover trading to past levels.
The same concerns are emerging this time. Should the regulatory stance on derivatives tighten, the launch of new products could shrink and investment demand could decline. In fact, individual stock weekly options, which the exchange had prepared for several months, saw their listing postponed as the regulatory controversy surrounding single-stock leverage ETFs spread. If regulation of single-stock leverage ETFs is tightened, funds could move to overseas ETFs or overseas derivatives, weakening the competitiveness of the capital market.
Experts also pointed out that the view of derivatives as the "main culprit" behind market volatility is being repeated this time. A former head of the Korea Exchange's derivatives market division said, "In the past, too, there was a strong perception that derivatives were the main culprit behind market volatility, but over time it turned out that there was an aspect of blaming a specific product for the volatility of the entire market." He added, "Single-stock leverage ETFs may also have expanded volatility somewhat, but tightening regulation by concluding that they are the cause of market instability requires caution." A research center head at a securities firm also said, "Recent stock market volatility had already grown due to external variables and shifts in supply and demand," adding, "Single-stock leverage ETFs, launched at the KOSPI's peak, are merely a factor that amplified this somewhat, not the starting point of market instability."
Financial authorities view supplementary measures as necessary for market stability and investor protection, and are issuing successive requests to the industry for related measures. In response, the industry stressed that while the structures that increase volatility should be reworked, this should not lead to regulation that shrinks the market itself. Where a balance is struck between investor protection and capital market competitiveness will determine the competitiveness not only of single-stock leverage products but of the derivatives market going forward.
