KOSPI surges 18% as leveraged ETF deleveraging nears completion

The KOSPI surged 17.91 percent to 6,595.45 on July 31, its biggest daily gain on record, as JP Morgan said the leveraged ETF and hedge fund deleveraging that had pressured the market was effectively complete.

"The deleveraging of leveraged ETFs tracking Korean underlying assets is effectively complete, and hedge funds are also estimated to have finished about 90 percent of their deleveraging," said Mixo Das, head of Korea equity strategy at JP Morgan. "While some additional liquidation may continue, large-scale selling pressure has largely been resolved."

Samsung Electronics closed at 262,500 won, up 26.8 percent, while SK Hynix jumped 29.95 percent to 1,718,000 won, hitting the daily limit. SK Square and Samsung Electro-Mechanics each rose 29.9 percent. The 1,001.89-point advance surpassed the 11.95 percent gain on Oct. 30, 2008, during the global financial crisis.

The rebound follows a roughly 40 percent drawdown from mid-June peaks as regulators tightened rules on leveraged products. Leveraged ETF assets tracking Korean stocks shrank 78.2 percent to 10.7 trillion won from a June 25 peak of about 49 trillion won, while margin loan balances fell to 52.9 trillion won, about 1.2 percent of KOSPI market capitalization.

The deleveraging unfolded across two layers, according to Huatai Securities strategy research. The first layer — bank and non-bank credit used to fund market investments — carried the risk of T+2 margin calls forcing liquidation. The second layer — leveraged ETF trading products — increased volatility through daily rebalancing cycles that drove both rallies and selloffs. Huatai estimated leveraged ETFs still contributed 11.4 percent of the 30-day average trading volume in Samsung Electronics and SK Hynix shares.

Regulators Tighten Leverage Rules

Korea's Financial Services Commission accelerated its policy response. On July 24, it moved the deposit threshold increase from 10 million won to 30 million won forward to July 31, requiring cash-only collateral. The regulator also authorized reducing the fixed 2x leverage ratio to 1.5x or 1x in emergencies, compressing the daily rebalancing flows that had driven both rallies and selloffs. Deputy Prime Minister and Finance Minister Choo Kyung-ho publicly apologized for not fully considering the risks when approving single-stock leveraged ETFs, and regulators are considering capping individual investment in such products at 20 percent of financial assets.

The VKOSPI volatility index remained elevated at 86.18 as of July 30, in the 99.6th percentile since 2005, though its ratio to the U.S. VIX has begun to decline. Samsung Electronics and SK Hynix together account for 51 percent of KOSPI market capitalization, and their high correlation in the memory chip sector concentrates index risk.

The regulatory tightening extends beyond Korea. Hong Kong's Securities and Futures Commission revised its framework for single-stock leveraged and inverse products, with CSOP Asset Management adopting a "flexible leverage" mechanism from Aug. 3 that allows leverage to vary between 1.1x and 2x. The CSOP SK Hynix Daily Leverage (2x) Product, which once exceeded HK$1.3 trillion in assets, has seen its market value evaporate by more than HK$1 trillion as SK Hynix shares fell nearly 46 percent from their June high.

Foreign investors turned net buyers on July 30, with MSCI Emerging Markets index weightings for Korea's largest stocks shrinking from 9.5 percent and 8.3 percent at end-June to 6.5 percent and 4.5 percent, indicating most long-term investor selling has been absorbed. Individual margin loan balances have declined to about $20 billion, with collateral maintenance buffers in place.

JP Morgan identified domestic consumer stocks — department stores, cosmetics, travel, securities and construction — as sectors to watch in the rebound phase, citing the wealth effect from rising asset prices. The bank also flagged bio-pharmaceuticals, preferred shares with wider discounts, and banks expected to benefit from expanded net interest margins.

The policy implementation window runs through mid-August, and Huatai expects the KOSPI to remain in high-volatility consolidation until then. After the policy shock fades, semiconductor fundamentals will determine the index's direction. Spillover to global markets has already receded — KOSPI's correlation with the S&P 500, Hang Seng and China's ChiNext has fallen 48.2 and 62.8 percentage points respectively from early-July highs.

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