Lessons from leveraged ETF fallout

Lee Chan-jin, governor of the Financial Supervisory Service, admitted on June 22 that approving single-stock leveraged exchange-traded funds tied to Samsung Electronics and SK hynix was a mistake. It is unusual for a senior government official to openly acknowledge a policy failure. Lee went further still, saying he "should have stopped it even if it meant throwing himself in the way." His remark raises an obvious question: Why wasn't it stopped before launch?

The backlash was swift. Online investment forums filled with criticism, with some accusing the FSS chief of incompetence and others arguing that ordinary retail investors had been left to absorb the losses. Two days later, the regulator sought to clarify the remarks, saying they were intended to warn investors about the risks of losses and highlight the need for stronger investor protections.

The head of the country's financial watchdog would not publicly admit a policy misstep unless the side effects had become impossible to ignore. The products in question track the daily movements of South Korea's two semiconductor giants, Samsung Electronics and SK hynix, at twice the gain or loss of the underlying shares. They were introduced to broaden investment options, deepen the domestic capital market and attract dollar inflows to South Korea, which in turn was expected to help ease pressure from a weak won.

Instead, the risks have increasingly eclipsed the benefits. The day after Lee's comments, the prices of 16 single-stock leveraged ETFs fell by more than 25% on average. Foreign investors sold semiconductor stocks and moved money out of the country, pushing the won-dollar exchange rate higher rather than lower. The exchange rate stood around 1,504 won per dollar before the products were introduced and is now approaching 1,550 won. Expectations of higher U.S. interest rates remain the primary driver of dollar strength, but heightened stock-market volatility has added to the pressure.

The impact of the Samsung Electronics and SK hynix leveraged products has extended well beyond South Korea, weighing on markets in the United States and Europe and prompting comparisons to a tail wagging the dog. Market observers on Wall Street have warned that the products are functioning less as investment vehicles and more as speculative instruments that amplify volatility.

Micron Technology, often viewed as a bellwether for Samsung Electronics and SK hynix, reported record earnings on June 24, helping lift the Kospi by more than 5% the following day. Yet concerns about an artificial intelligence bubble have hardly faded. With higher U.S. interest rates still expected, investors continue to worry that financing costs for AI companies will rise. If those concerns prove justified, South Korea's semiconductor sector, one of the chief beneficiaries of the AI boom, could face significant headwinds.

The time to reinforce safeguards is before the storm arrives, not after. Regulators should move quickly to strengthen the framework surrounding single-stock leveraged products. Options include imposing limits on excessive daily turnover or requiring more extensive investor education before trading is permitted.

Brokerages, too, should examine whether they allowed themselves to become swept up in the euphoria of a bull market. Signs of excessive promotion have already emerged. Separate allegations have surfaced that some asset managers marketed ETFs linked to SpaceX as though allocations in a future public offering had effectively been secured. In an overheated market environment, there is every reason to question whether some products were sold with adequate safeguards in place.

The Board of Audit and Inspection has launched a review of financial regulators, but authorities should also conduct their own assessment of whether gaps emerged in market oversight. As the Kospi surged this year, calls grew louder for measures to prepare for an eventual downturn. Yet warnings from regulators remained muted. Critics argue that authorities were reluctant to dampen enthusiasm for a booming stock market that the government viewed as a policy success. That criticism deserves careful consideration.