From “National Fortune ETF” to “Blood-Red July”: How Will South Korea’s Leveraged Stock Market Crisis Be Disarmed?

By Jae, PANews

On July 17, South Korea’s stock market closed for the Constitution Day holiday, but the smoke from the turmoil did not clear. Samsung Electronics- and SK hynix-related issues continued to face sell-offs in other markets. At the close of trading in Hong Kong, leveraged ETFs from Southern Dongying—2x long on Samsung and 2x long on SK hynix—both fell by about 20%. There is no doubt that South Korea’s capital markets are going through an epic “deleveraging” tsunami in the height of summer.

Over the past half month, the wild myth of “everyone trading stocks” has been ruthlessly crushed by cold liquidation data. Two months ago, 2x leveraged ETFs on individual stocks of SK hynix and Samsung Electronics were still packaged as a wealth shortcut to “share the national fortunes,” with regulators themselves loosening the rules and retail investors rushing in, hoping to get a slice of the semiconductor bull market. But when industry expectations shifted and the market pulled back, this leveraged tool instantly turned into a “mincer.”

Facing a double squeeze of the market running out of control and banks “cutting off” credit supplies, President Lee Jae-myung stepped in urgently. In one night, regulators delivered “seven heavy punches,” but before that, hundreds of thousands of Korean retail investors had already entered the darkest moment in which principal went to zero.

$1.45 billion disappears into thin air; principal wiped to zero for 460k accounts, more than 60% are young investors

In mid-July, for retail investors betting on South Korea’s semiconductor track, every trading day was rewriting records of pain.

In just 9 trading days, leveraged ETFs on stocks that retail investors piled into recorded cumulative unrealized losses of more than 88 trillion Korean won (about $595 million). Of that, the share of holdings in leveraged products by individual investors is as high as 60%. This means that almost all of the “explosive” sell-off was detonated in ordinary retail accounts with the weakest risk tolerance.

According to Bloomberg statistics, over the past month, South Korean retail investors suffered economic losses of up to $1.45 billion (about 2 trillion Korean won) from high-leverage trading. However, the more brutal wave of forced liquidations was still coming: across the entire market, more than 1.2 million retail leveraged accounts triggered the “life-and-death line” for margin calls. Since they could not make up the required “ammunition” within the specified time, 460,000 accounts were cleared to zero with one click by brokers, and investors aged 20–30 accounted for 62% of the total liquidations. Not only did their principal go directly to zero, but there was also the absurd tragedy of “owing the broker money”—young investors were given a painful lesson by the market.

This forced-liquidation wave peaked in mid-July. From July 1 to July 13, the cumulative forced liquidation amount reached 451.9 billion Korean won (about $305 million). Of this, the single-day forced liquidation amount on July 9 hit 142.2 billion Korean won (about $95.2 million), and the forced liquidation ratio surged to 10.2%. On July 13, the total forced liquidation amount across the entire market for a single day rose to 344.2 billion Korean won (about $232 million), setting the highest record so far this year.

Panic on the trading screen amplified in tandem. SK hynix, which retail investors had essentially bet their positions on in near-full exposure, plunged more than 15% on July 13, recording its largest single-day decline in 18 years. The 2x long ETF linked to its underlying stock also crashed by 30% in a steep, cliff-like drop. South Korea’s benchmark equity index, KOSPI, fell nearly 9% intraday, triggering circuit breakers for the 7th time this year, with a cumulative drawdown of as much as 25% from the historical high in June.

Market panic emotions rolled like a snowball—growing bigger and bigger under the amplification of the leverage mechanism. The mass forced liquidations among retail investors are not driven solely by falling stock prices. The daily rebalancing mechanism embedded in individual-stock leveraged ETFs is the “disaster engine” that turns a pullback into a stampede.

Related reading: Leveraged products trigger a major change in the stock market—how did South Korea’s stock market become a “casino”?

What’s worse, many retail investors lacking risk-control awareness chose to “hold on to death” during the decline, and even kept adding positions in an attempt to average down their cost. This classic “gambler-style” behavior made their exposure grow larger and larger, ultimately accelerating the plunge into the abyss of forced liquidation.

Bank credit supply cut off; the central bank adds the finishing blow with a rate hike

On-exchange leveraged trading is the blade of the meat grinder; the depletion of off-exchange credit is the suction pump that drains the last drop of blood from retail investors.

Koreans “borrow money to trade stocks” has long been a common practice. During the first half’s bull market, demand among retail investors for leverage surged as they liquidated through housing mortgages and consumer loans. But to curb the malicious expansion of household debt, South Korea’s regulators set a hard cap of 1.5% on the annual growth rate of household lending by commercial banks.

Yet this red line at mid-year turned into a tightly wound noose. By the end of June, the household loan balances of South Korea’s top five commercial banks increased by 3.7 trillion Korean won (about $250.2 million) compared with the beginning of the year, having already used up 85.3% of the annual lending quota. The remaining quota was only about 639.5 billion Korean won ($43.1 million). Even two banks had already exceeded their targets early. In the second half, not only could they not make new loans, they would also have to recall existing loans, forcing the quota back down.

This also means that when the stock market crashed in July and 1.2 million accounts collectively triggered margin call notices, retail investors suddenly realized: they could not borrow money. Without incremental funds to add, the only thing left for them was forced liquidation by brokers.

To make matters worse, there was an unexpected rate hike from the Bank of Korea. On July 16, when market liquidity was already extremely fragile, the central bank threw a major bombshell: it announced an increase of 25 basis points to the benchmark interest rate, to 2.75%, its first shift toward tightening in more than 3.5 years. Although the initial policy goal was to narrow the Korea–U.S. interest-rate spread, ease capital outflows, and stabilize the won exchange rate, during the forced-liquidation wave, raising rates was no different from salting the wound of deleveraging.

That day, KOSPI plunged 6.37%, and SK hynix fell 11.53%. The negative feedback loop of deleveraging was ignited.

Seven urgent brake steps—no disarming, just cutting off food

The grim tragedy of widespread principal going to zero quickly escalated into a political issue. Prior to this, Ahn Cheol-soo, a lawmaker of the People Power Party, had already sharply criticized on social media that KOSPI had “turned into a casino.”

In the face of the label of a “casino for national fortunes” and the horrifying reality that hundreds of thousands of families’ wealth had been wiped out, South Korean President Lee Jae-myung personally singled out the individual-stock leveraged ETFs of Samsung and SK hynix, ordering the financial authorities to quickly roll out countermeasures.

On July 16, the F4 agreement mechanism—made up of the Financial Services Commission, the Financial Supervisory Service, the Ministry of Economy and Finance, and the central bank—urgently issued a package of tough new regulations in the form of “shock therapy,” aiming to cool down this leveraged “high fever.”

It is worth noting that regulators did not choose to directly force existing ETFs to delist. In panic, forcibly “pulling the plug” could trigger even more severe liquidity stampedes. The real logic of regulators was: do not proactively puncture existing bubbles; instead, raise the entry threshold and cut off new funding so that the market moves into a long period of passive clearing.

As the new rules are about to take effect, the institutional framework for South Korea’s individual-stock leveraged market will be forcibly reshaped. The frenzy of speculative mania is expected to temporarily recede. But the risks have not truly been removed. At present, South Korea’s stock market still has an outstanding credit financing balance of more than 35 trillion Korean won (about $235.5 million). Against the backdrop of a credit tightening and a rate-hike cycle, existing leveraged accounts have effectively lost their cushion.

The cold financial winds in Seoul have awakened retail investors who had drowned in the frenzy of the stock market. Leverage innovation that is divorced from support by investors’ real incomes and from strict regulatory constraints, in essence, is nothing more than piling up a wealth bubble. When a large bearish red candle crashes down, all the fabricated prosperity will be liquidated by the market—and ultimately, the cost is often borne by the weakest retail investors.