Single-stock leverage ETF paper trading made mandatory from Wednesday

Starting Wednesday, tighter tracking error management standards will take effect for exchange-traded funds and exchange-traded notes, and individual retail investors newly entering single-stock leverage products will be required to complete at least five hours of paper trading.

The Financial Services Commission approved the amendments to Korea Exchange's KOSPI market operating rules at its first extraordinary regular meeting Wednesday.

Under the revised rules, brokerages' tracking error management obligations for all ETFs and ETNs will be tightened from the current closing-price thresholds of 3 percent for domestic products and 6 percent for overseas products to 2 percent and 5 percent, respectively. The methodology for calculating tracking errors will also be clarified — when a tracking error is negative, its absolute value will be used in the calculation.

Sanctions against brokerages that willfully, with gross negligence or repeatedly violate tracking error management obligations will also be stiffened. Korea Exchange plans to restrict the new liquidity supply operations of the offending brokerage's liquidity providers through amendments to the KOSPI market operating rules enforcement guidelines.

The process for designating securities as investor-caution items will also be streamlined, reduced from the current three-step procedure — identification, advance notice of designation, and designation — to two steps, combining identification and advance notice before the final designation.

"These measures are expected to strengthen the tracking error management framework and reduce the likelihood that investors buy ETFs and ETNs at prices above their actual value or sell them below it, thereby enhancing investor protection," the FSC said.

The barrier to entry for single-stock leverage products will also rise. Korea Exchange will extend its paper trading service — currently available for futures, options and short selling — to domestically and overseas-listed single-stock leverage products starting Wednesday.

New investors must complete paper trading over five trading days, with at least one hour per day, for a minimum of five hours in total.

The requirement is designed to let prospective investors experience firsthand the risks of single-stock leverage products before deciding whether to invest. Such products can generate losses even when the underlying asset moves sideways, due to the negative compounding effect.

Individual retail investors seeking to make new investments in domestic or overseas-listed single-stock products must hold a base deposit of 30 million won ($21,200), complete three hours of mandatory education — one hour of basic and two hours of advanced instruction — and finish the paper trading requirement.

"While stock market volatility has eased somewhat recently, destabilizing factors remain, so we will closely monitor market conditions and swiftly advance the single-stock leverage product improvement measures announced on July 16 and July 29," an FSC official said.