Gov't tightens rules on single-stock leveraged ETFs, but doubts linger over real impact

The government has moved to sharply tighten regulations on single-stock leveraged exchange-traded funds amid growing volatility in the stock market.

The measures are intended to raise the investment threshold, curb short-term speculative demand and cool market overheating — but voices within the financial investment industry are split, with some expecting a degree of effect and others cautioning that meaningful volatility reduction may have its limits.

Deputy Prime Minister and Minister of Economy and Finance Koo Yun-cheol convened a market conditions review meeting at the Korea Federation of Banks building in Seoul on Thursday and finalized a package of supplementary measures for single-stock leveraged ETFs.

The centerpiece of the package is a tighter entry requirement for investors. The basic deposit is currently 10 million won ($6,720), a portion of which can be met with existing stock holdings, but going forward investors must hold the full 30 million won in cash to trade single-stock leveraged ETFs. In effect, the minimum cash requirement will rise tenfold — from roughly 3 million won to 30 million won.

Trading rules will also change. Shares can currently be bought and sold in single-unit increments, but transactions will be restricted to lots of 20 shares. The government expects the higher minimum trade size to naturally reduce short-term turnover and frequent small-lot dealing. The higher deposit requirement takes effect in August, while the new trading unit will be introduced in November to allow brokerage firms time to update their systems.

Market oversight standards will be tightened as well. The permissible tracking error — the gap between an ETF's net asset value and its market price — will be narrowed from 3 percent to 2 percent. The procedure for designating a security as a caution-flagged investment will also be streamlined from three stages to two.

The mandatory investor education required before trading single-stock leveraged ETFs will be extended from two hours to three, and new listings of such products will be suspended until the market stabilizes. Advertising and marketing activities for existing products will also be restricted.

Industry participants broadly expect the measures to help cool overheated investor sentiment in the near term. The higher deposit requirement and larger minimum trading unit have drawn a positive reception from some quarters.

"A significant number of retail investors in single-stock leveraged products are drawn by the prospect of high returns on relatively small capital," one industry official said. "Raising the deposit threshold to 30 million won should reduce new entrants and can be expected to have some effect in easing short-term overheating."

Another industry official said tightening the deposit standard and expanding the trading unit could slow trading volume and turnover to some extent. "There have been past cases where similar regulatory changes led to a drop in trading activity, so it will be worth watching how the market responds," the official said.

Some, however, worry that certain measures could end up constraining market function. An official at one asset management firm said orders are often spread out and executed before the close of trading in practice to reduce end-of-day price swings. "Some tracking error can arise in that process, and if the focus is solely on pushing the tracking-error figure down, it is hard to rule out the possibility that market price distortions could actually worsen," the official said.

There are also those who argue the package falls short of addressing the root causes of market overheating. One industry official said the measures were focused on raising barriers to entry but stopped short of more direct tools such as trading halts. "How much the measures will actually reduce market volatility remains to be seen once they take effect," the official said.