A regulatory miscalculation in South Korea: how ETF restrictions accidentally drove small-cap companies up 30%
South Korean financial authorities, in an attempt to cool the overheated stock market, introduced restrictions on the use of borrowed funds in exchange-traded funds (ETFs). However, the effect turned out to be the exact opposite of what was expected: instead of stabilizing the market, regulators triggered an even more aggressive speculative wave that hit the small-cap segment.
The restrictions affected leveraged ETFs focused on shares of giants such as Samsung Electronics and SK Hynix. Regulators also raised cash collateral requirements for retail investors. But capital did not leave the market — it simply changed direction. Private funds poured en masse into small companies on the KOSDAQ index, which has already risen 30% from its July 30 low.
KOSDAQ: a new epicenter of speculation
On Monday, the KOSDAQ index surged 6.8%, triggering an automatic trading halt on the Korea Exchange — the third time this month. This is a striking indicator of just how nervous and overheated the market has become.
Park Weil, a global ETF analyst at Shinhan Securities, notes: "We are seeing growing inflows into KOSDAQ, especially today. Retail investors who love high volatility and moved into single-stock leveraged ETFs are likely to return to KOSDAQ." This confirms that regulatory measures did not stop speculative fervor — they merely redirected it into a less liquid and riskier segment.
Recall that earlier, the KOSPI index plunged roughly 40% from its June peak to a low in late July. The sell-off was triggered by artificial intelligence-based instruments, followed by forced liquidations and the mass unwinding of margin positions worth billions of dollars. The leveraged ETF on SK Hynix fell 45% during that period. Regulators have finally admitted that such products only amplified market swings.
The widest gap between KOSDAQ and KOSPI since 2000
Last week, KOSDAQ rose steadily while KOSPI lost ground. The divergence in performance between small caps and the benchmark index is now the largest since the dot-com era. Retail investors in Korea have historically favored highly volatile instruments, and this approach now even drives the local crypto market: during the height of the AI stock sell-off, bitcoin fluctuated less than the KOSPI index.
The same audience that fueled the semiconductor ETF boom is now rushing into small-cap stocks. Regulators are again lagging behind the market, reacting to events that have already happened rather than preventing them.
My analysis: The sustainability of the KOSDAQ rally directly depends on whether the sell-off in AI stocks in Korea has concluded. If this is merely a repeat of the previous speculative cycle, trading halts will keep triggering again and again. Investors should remember: regulatory measures do not eliminate risk — they only change its location.