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The head of South Korea’s Financial Supervisory Service (FSS), Lee Chan-jin, has reiterated his warning to individual investors who borrow excessively to bet on rising stocks that this could lead to ruin. The risk of financial disaster increases when savings are funneled into a few select investments or money is borrowed.
Lee spoke on the issue at the recent meeting of the FSS’s consumer-risk council at the agency’s headquarters in Yeouido, Seoul. He advised banks and brokers to manage risks better and to respond to them as soon as possible. Lee reportedly urged financial companies to highlight the risks of leverage to investors and to take action against those that encourage clients to speculate with borrowed money.
This warning has come at a time when the local stock market is witnessing a boom thanks to the various factors that are transforming the Korean financial system. The benchmark KOSPI index has been performing extremely well thanks to a global spending wave for AI data centers. However, with the gains have come sharper volatility. In light of the aforementioned situation, between May 27 and June 22, retail investors invested over 8.9 trillion won ($5.8 billion) in total in leveraged exchange-traded funds (ETFs) tied to single heavyweight stocks.
Debt-fueled investing surges
The phenomenon behind the advisory indicates a significant increase in the funds borrowed by the investors pursuing such trades, popularly known as “빚투,’ which means investing on debt. According to Chosun, the credit-loan balances at brokerage firms surged to 37.3 trillion won in the month of June, up from 32.9 trillion won by the end of March. During the same period, the number of forced liquidations resulting from margin calls more than doubled, rising to 52.7 billion won in June from 26.2 billion won in March. This is exactly what the FSS is worried about: when losses on a leveraged position become too large, the brokerage automatically closes the position, turning paper losses into real ones.
A leveraged ETF uses derivatives and borrowing to magnify the daily changes in value of the underlying asset. Therefore, a 2x ETF aims to deliver two times the return for the given period of time. The US Securities and Exchange Commission (SEC) states that these funds are reset daily and can deviate significantly from the multiplier factor over weeks or months, especially in volatile markets. In one example from the SEC, the performance of an index was a gain of 2 percent over four months, but a 2x fund had lost as much as 6 percent over the same period.
Single-stock ETFs at the center
Much of the concern points to 16 single-stock leveraged and inverse ETFs tracking Samsung Electronics and SK Hynix, launched on May 27. Fourteen of them aim to deliver twice the daily move of the chipmakers, the Korea Times reported. The products were promoted as a way to keep Korean retail money at home rather than flowing into US stocks, and were cleared by the Financial Services Commission (FSC) and the Korea Exchange.
Lee has made it clear how he feels on the subject in public. He has stated that there was “minimal” profit while “side effects have become too significant” and that it was a case of “the tail is wagging the dog.” According to him, there has been enough of a question of whether these products are suitable for the retail market. There was also talk of possible restrictions being imposed on margin-based trading and credit-backed trading. As of June 22, the amount of money invested in the Samsung and SK Hynix leverage ETF has now reached 14 trillion won, with retail investors holding nearly 92 percent of it. Several of the funds had already dropped as much as 24 percent from recent highs.
There has been pushback against this statement made by the governor. He has claimed that he has estimated that the revenue generated through turnover of money from the trading of these products is going to be somewhere in the range of 10 trillion won. This claim has been refuted, though, by Hwang Seong-yeop, who is the head of the Korea Investment Association, who estimated the revenue at 50 billion won since the launch of this product. An FSS official later said the 10 trillion won figure was an annualized projection based on current turnover.
The FSS has also raised this alarm earlier this year. In March, the organization warned about the level of turnover for leveraged and reverse investment being raised to 5.6 trillion won this year against 1.6 trillion won last year.
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