The South Korean stock market suffered another significant blow, prompting regulators to expedite deleveraging measures amidst a persistent high-volatility environment.

On Monday, the KOSPI index tumbled 5% to close at 6,241 points, with the KOSDAQ index's decline triggering a sidecar mechanism, halting program trading for five minutes. Heavyweight stocks like Samsung Electronics and SK Hynix each fell over 7%, unleashing a wave of market panic.

Simultaneously, reports indicate that South Korean financial authorities are considering the introduction of an "emergency action authority" that would allow them to directly reduce the leverage multiples of single-stock leveraged ETFs during periods of extreme market volatility. Currently, these products typically track 2x returns. If the emergency authorization is triggered, the leverage could be lowered to 1.5x, and in the most severe cases, to as low as 1.1x.

Regulatory escalation: Plans to legislate an "emergency action authority"

In response to the ongoing turmoil, South Korean financial regulators are advancing more robust institutional responses. The Financial Services Commission (FSC) and the Financial Supervisory Service (FSS) have reportedly begun revising the Capital Markets Act. The core of the proposal is to grant regulators the power to directly adjust the leverage of single-stock leveraged ETFs—from the current 2x down to 1.5x, or as low as 1.1x in extreme cases—without requiring a separate product modification process when market instability or urgent investor protection issues arise.

This legislative approach draws inspiration from the "flexible leverage" mechanism implemented by the Securities and Futures Commission (SFC) of Hong Kong on July 24. Hong Kong's rules require fund managers to flexibly adjust leverage ratios daily based on market conditions, disclosing the target leverage for the next trading day after the market closes. Under extreme market conditions, the leverage can be lowered to a minimum of 1.1x. CSOP Asset Management began applying the flexible leverage structure to all 12 of its single-stock products listed in Hong Kong starting August 3.

Unlike Hong Kong's model, which primarily relies on fund managers' discretion, South Korea's proposed "emergency action authority" gives regulators proactive intervention power. Its scope is not limited to single-stock leveraged ETFs but also covers various market participants. Additionally, measures such as "suspending new subscriptions" and implementing "single-price trading" for specific stocks are also under consideration.

However, the proposal still faces legislative hurdles. Current South Korean law generally requires a beneficiary meeting to change the leverage ratio of an existing product, needing approval from a majority of votes cast and at least one-quarter of outstanding beneficiary certificates. This makes it difficult to respond quickly to rapid market changes. FSC Capital Markets Bureau Director Byun Je-ho previously stated, "This requires convening a beneficiary meeting, which is even more difficult than a shareholder meeting."

Early measures show some effect, but leverage reduction remains incomplete

This regulatory escalation is a continuation of a series of policy actions. Sixteen single-stock leveraged ETFs were launched on May 27, with their total market capitalization swelling rapidly from 4.4 trillion won (approximately $3.1 billion) on the first day to 11.9 trillion won (approximately $8.3 billion) by July 15. Their average daily trading volume also increased from 10.4 trillion won to 13 trillion won.

Regulators rolled out a first round of supplementary measures on July 16, including suspending new product launches, banning advertising, and extending mandatory pre-investment education to three hours. A second round of measures was introduced on July 29, requiring individual investors to hold 30 million won (approximately $21,000) in cash to purchase or increase their positions. On the first day these measures took effect on July 31, trading volume for the 16 related products plummeted by 75.5% to approximately 3.05 trillion won, with their share of total KOSPI turnover dropping from a July average of 33.8% to 6.4%.

However, institutional analysts believe that data from a single day is insufficient to judge the policy's effectiveness. Guotai Hai Tong research reports indicate that, based on a composite of margin balance and leveraged ETF net subscription/redemption indicators, the overall leverage level has only seen a limited decline, hovering around 50% on most trading days since July. Although the ratio of margin balance to deposits has fallen from its earlier highs, it is still at the 16th percentile of the ten-year historical range. Further improvement in overall leverage depends on a slowdown in leveraged ETF inflows and stabilization of deposits.

Huatai Securities research suggests that the current regulatory approach in South Korea is to "control increments and digest stock," aiming to lower the market's volatility, which remains at historically high percentiles. In the short term, the accelerated regulatory pace raises concerns about leveraged ETF redemption risks. The South Korean stock market is likely to maintain high-volatility fluctuations until the policy is implemented in mid-August, with a medium-term return to fundamentals like semiconductor and storage logic.

Policy controversy: Consistency and investor rights questioned

The "emergency action authority" plan has sparked significant backlash in the market. Critics argue that regulators approved the products' listing under the guise of "investor choice" and "financial product diversification," only to pause new listings and ban advertising after a large influx of capital. Now, they are adding leverage controls on top of deposit requirements and investment limits, raising questions about policy consistency.

The protection of existing investors' rights is also a key concern. If a product purchased with a 2x return expectation is converted by regulatory decision into a 1.5x product, investors would face terms different from those at the time of contract signing. Kiwoom Securities analyst Kim Jin-young pointed out, "Leverage decisions are based on market conditions and capacity limits, and there is a risk of reduction when it is unfavorable to investors. If the leverage is cut from 2x to 1.5x just before a sharp rise in the underlying stock, investors may not achieve the expected returns."

Conversely, Bae Jae-gyu, CEO of Korea Investment Trust Management and known as the "father of Korean ETFs," holds a different stance. He believes single-stock leveraged products should "naturally die out rather than be forcibly delisted" and emphasizes that daily rebalancing and compounding effects can rapidly erode product value when volatility rises and prices fluctuate.

One financial investment industry insider stressed, "If the government wants to introduce an emergency action authority, it must first clearly define 'emergency situations' at the legal level, including the trigger time limit, the lower limit of leverage, the decision-making process, and the notification and exit arrangements for existing investors."

Market participants generally view the trigger criteria for the emergency authority and market predictability as the key variables determining whether the mechanism can truly reduce volatility.