Regulatory miscalculation in South Korea: how ETF restrictions drove small-cap companies up 30%
An attempt by South Korean financial authorities to cool down an overheated stock market has produced the exact opposite result. Restrictions on the use of borrowed funds in exchange-traded funds (ETFs) not only failed to calm speculators but also triggered an explosive surge in small-cap stocks, while crashing the large-cap chip market.
At the center of attention were leveraged ETFs tied to shares of giants such as Samsung Electronics and SK Hynix. Regulators tightened deposit requirements for retail investors, hoping to reduce volatility. However, capital did not leave the market—it simply changed direction. Funds poured en masse into small companies on the KOSDAQ index, which has soared 30% from its July 30 low.
On Monday, the KOSDAQ index jumped 6.8%, triggering an automatic trading halt on the Korea Exchange for the third time this month. This rare event underscores the extraordinary nature of the current situation. Speculative capital, driven out of the semiconductor sector, has found a new haven in less liquid but more volatile assets.
Notably, the leveraged ETF on SK Hynix has crashed 45% over this period. Regulators have effectively admitted that their own products exacerbated market fluctuations. We are now witnessing the classic "liquidity spillover" effect: instead of extinguishing the fire, authorities have merely shifted it to a new front.
KOSDAQ vs. KOSPI: A Historic Divergence
Last week, KOSDAQ rose steadily while the main KOSPI index lost ground. The gap in performance between small caps and the benchmark index is now the widest since the dot-com era. This suggests we are dealing not with a temporary deviation but with a fundamental shift in retail investor behavior.
Korean retail traders have historically favored high-risk instruments, and it was this very audience that previously inflated the boom in semiconductor manufacturer ETFs. Now, the same cohort of investors has switched to KOSDAQ. Analysts note that inflows into this segment continue to grow, and retail investors are likely to keep returning to KOSDAQ in search of high volatility.
Remarkably, during the height of the sell-off in AI stocks, bitcoin showed less volatility than the KOSPI index. This underscores just how nervous and skewed the Korean market has become.
The sustainability of the KOSDAQ rally now depends on whether the sell-off in the AI sector is truly over. If this is merely a repeat of the previous speculative cycle, exchange circuit breakers will keep triggering, and regulators will continue playing catch-up with the market.
My analysis: This case is a vivid example of how administrative measures that ignore behavioral factors backfire. The market will always find a path for speculative capital. As long as regulators fail to address the root cause—excessive leverage among retail investors—such "accidental" rallies will keep recurring.