Kospi's 61% rally faces new risk as regulators tighten leveraged ETF rules

South Korea's benchmark Kospi has surged 61% this year, but the rally's foundation — extreme concentration in two AI chip stocks and a retail trading frenzy — is drawing regulatory scrutiny.

South Korea's Kospi has surged 61% this year on AI chip demand, but regulators are moving to curb the speculative trading fueling its volatility.

"The emergence of ETFs as mainstream investment vehicles is both an opportunity and threat for the Korean equity market," said Peter S. Kim, analyst at KB Financial Group.

Samsung Electronics and SK Hynix, up 117% and 181% respectively this year, now account for over half the index's weight. Retail investors poured $9.45 billion into single-stock leveraged ETFs since their May 27 launch, while institutional foreign investors have become net sellers. The products at times accounted for as much as 35% of Kospi turnover, and annualized volatility has climbed to about 80% since May, HSBC data show.

The regulatory push may moderate speculative activity, but analysts say it will do little to address the structural concentration that leaves the market vulnerable to AI-demand shifts. With few compelling growth stories outside of technology, both domestic and foreign investors are piling into the same small group of stocks, said William Bratton, APAC head of cash equity research at BNP Paribas.

Leverage Amplifies Market Swings

HSBC estimates the leveraged products grew from virtually nothing to about $12 billion within a month, with another $15 billion of similar products listed in Hong Kong. "That can be exhilarating on the way up. It can also become destabilizing on the way down," strategists led by Herald van der Linde wrote.

The Kospi has fallen as much as 28% from its June record high, triggering multiple circuit breakers this year. Fundstrat's Tom Lee estimated that 1.2 million brokerage accounts — as much as 10% of Korea's accounts — faced margin calls during the downturn.

Regulatory Tools Face Adaptive Markets

President Lee Jae Myung has told regulators to implement measures "quickly and aggressively." Authorities suspended new listings of single-stock leveraged ETFs and tripled the minimum deposit requirement for leveraged ETF trading.

But analysts question the effectiveness. Financial markets are adaptive, and investors can adjust to higher trading costs, said Marcus Weyerer, director of ETF investment strategy at Franklin Templeton. Citi estimates Korean households still have $68 billion to $167 billion of potential equity investment capacity through the first quarter of next year.

The Kospi's correlation with the Nasdaq-100 has reached 0.95, Evercore ISI data show, meaning the two markets move almost in lockstep as investors treat South Korea as a proxy for the AI trade. "[The market's lack of breadth] may prove to be an ongoing deterrent for the longer-term capital that the country is seeking to attract," BNP Paribas' Bratton said.

This article is for informational purposes only and does not constitute investment advice.