The Butterfly Effect of Regulation: How South Korea Accidentally Drove Away Small Companies by 30%
South Korea's financial authorities, in an attempt to cool an overheated market, introduced restrictions on the use of borrowed funds in exchange-traded funds (ETFs). The result was the exact opposite of expectations: instead of stabilizing, the market received a new dose of turbulence, and capital rushed into the small-cap segment.
At the center of attention were leveraged ETFs on the shares of giants Samsung Electronics and SK Hynix. Regulators tightened deposit requirements for retail investors, but this did not stop speculative pressure. Instead of leaving the market, private capital flowed en masse into small-cap stocks of the KOSDAQ index. The result — an impressive 30% rise from the July 30 low.
The Regulation Paradox: KOSDAQ vs. KOSPI
On Monday, the KOSDAQ index jumped 6.8%, triggering an automatic trading halt on the Korea Exchange — the third time this month. This event marked the deepest divergence between the performance of small caps and the elite KOSPI index. In essence, we are witnessing the largest performance gap between these benchmarks since the dot-com era.
Analysts note that retail investors, driven out of the high-risk leveraged ETF segment, are returning to KOSDAQ. Park Wel, a global ETF analyst at Shinhan Securities, comments: "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."
Notably, the KOSPI index had previously plunged about 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 mass closure of margin positions worth billions of dollars. The leveraged ETF on SK Hynix fell 45% during this period. Authorities admitted: such products only amplified market fluctuations.
By tightening deposit requirements but failing to assess the trajectory of speculative capital, regulators effectively created a new hotspot of tension. Now, the same audience that inflated the ETF boom on semiconductor manufacturers has shifted to small-cap stocks.
My analysis: The sustainability of the KOSDAQ rally will depend on whether the sell-off in Korean AI stocks is truly complete. If this is merely a repeat of the previous speculative cycle, exchange circuit breakers will continue to trigger, and the market will remain hostage to regulatory short-sightedness.