Rep. Kim Hyun-jung Proposes Capital Markets Act Amendment to Mitigate Market Volatility

Capital Markets Act Amendment Proposed to Ease Market Volatility and Ensure Flexibility in Leveraged Products

Rep. Kim Hyun-jung of the Democratic Party, a member of the National Assembly's Political Affairs Committee, has put forward a legislative amendment that would allow the leverage ratios of leveraged financial products to be flexibly adjusted according to market conditions, in response to the recent sharp fluctuations in South Korea's capital markets. The bill aims to address issues where leveraged Exchange Traded Funds (ETFs) and Exchange Traded Notes (ETNs), which track the return of a specific index by a multiple, can inflict substantial losses on investors or exacerbate overall market instability during rapid market shifts. Specifically, the amendment focuses on establishing a legal basis for financial authorities to directly adjust leverage ratios during market crises or for asset managers to respond with flexibility.

Under the current Capital Markets Act framework, the leverage ratios of these products are fixed at the design stage. This structure can lead to mechanical selling even in periods of market decline or extreme volatility. It has been pointed out that this can create a vicious cycle during stock market crashes, where the sale of underlying assets by leveraged products further accelerates the market decline. An official from Rep. Kim Hyun-jung's office emphasized that institutional safeguards are essential to prevent abrupt market concentration and protect individual investors, explaining the legislative intent. Statistics show that the domestic leveraged products market has grown significantly in recent years, with individual investors accounting for over 60 percent of participation, underscoring the increasing importance of market risk management.

In-depth Analysis of Flexible Leverage Ratio Operation and Market Stabilization Mechanisms

The core of this amendment is to grant flexibility to lower or temporarily restrict leverage ratios during abnormal market conditions such as overheating or sharp downturns. For example, if the volatility index (VIX) exceeds a threshold, such as when the KOSPI 200 index experiences a daily fluctuation of over 5 percent, the leverage ratio, currently fixed at 2x, could be adjusted to 1.5x or 1x to prevent rapid depreciation of asset values. The financial investment industry expects that such a mechanism, if introduced, would reduce mechanical selling in the index futures market, acting as a shock absorber for the broader stock market.

President Lee Jae-myung recently stated at a Cabinet meeting that policies should follow the circumstances of the people, rather than forcing people's lives into pre-existing systems. This sentiment appears to be extending to capital market policies. The bill reflects a will to move beyond rigid regulatory frameworks and operate systems flexibly based on the actual risks in the investment landscape. In fact, analyses from specialized institutions like the Korea Capital Market Institute suggest that even a modest 10 percent flexible adjustment in leverage ratios could reduce forced liquidation volumes during sharp market downturns by approximately 15 percent.

However, some express concerns that such ratio adjustments could deprive investors of profit opportunities or infringe upon operational autonomy. This is because if leverage ratios are set low during a market rebound, investors may not achieve their expected returns. In response, the amendment includes safeguards such as clearly defined numerical criteria for ratio adjustments and a requirement for approval from the Financial Services Commission, thereby preventing arbitrary operation. This is interpreted as an effort to strike a balance between regulation and market autonomy.

Practical Impact on the Asset Management Industry and Individual Investors

Should the Capital Markets Act amendment pass and be enacted, significant changes are anticipated in the product design strategies of the domestic asset management industry. In the ETF market, currently led by major asset managers like Samsung Asset Management and Mirae Asset Global Investments, risk management capabilities are expected to emerge as a key factor in product competitiveness. Asset managers with algorithms capable of optimal ratio adjustments based on market conditions, rather than simply offering high leverage, are likely to gain investor trust. This is expected to mark a transition for the Korean fund market from quantitative growth to qualitative growth.

From an individual investor's perspective, the institutional management of the risks associated with highly high-risk, high-return leveraged products is a significant positive. It essentially provides a form of automatic braking system for small investors who have been vulnerable to market swings. Data from the Financial Supervisory Service indicates that the average holding period for leveraged product investors is more than 30 percent shorter than for regular ETFs, suggesting extreme vulnerability to short-term volatility. This bill is also expected to have a subsidiary effect of guiding such short-term speculative demand towards stable long-term investment.

Furthermore, the securities industry anticipates that linking leverage ratio adjustments with credit extensions and margin trading could have a cascading effect of lowering the overall leverage levels in the market. This is seen as a fundamental measure to improve the structure of the stock market and enhance its resilience to external shocks. Within the National Assembly's Political Affairs Committee, there is a consensus across party lines on the necessity of the amendment under the overarching principle of investor protection, suggesting that the legislative process may gain momentum.

Future Legislative Outlook and the Future of Korea's Capital Market Safety Net

The Capital Markets Act amendment proposed by Rep. Kim Hyun-jung is expected to proceed through the legislative process, starting with a subcommittee review before being presented to the full assembly. In conjunction with the government's ongoing corporate value-up program, various legislative efforts are underway to enhance transparency and stability in the capital markets. Particularly, with the Lee Jae-myung administration emphasizing the realization of economic justice alongside balanced national development during its term, tackling unfair practices within the capital markets and refining risk management systems are likely to be policy priorities.

The President's statement that policies should follow the circumstances of the people and not force lives into pre-existing systems serves as the philosophical backdrop for this capital market reform.

Experts predict that this amendment will be a stepping stone to elevate the risk management standards of the Korean capital market to a new level, going beyond mere adjustments to leverage ratios. Moving forward, financial authorities will need to establish specific guidelines for ratio adjustments through detailed enforcement decrees and continuously communicate with market participants to assess the effectiveness of the system. Technical enhancements, such as introducing an AI-based market monitoring system to improve the speed and accuracy of ratio adjustments, are also expected to be pursued in parallel.

In conclusion, this bill offers an advanced response to how the inherent volatility of capital markets should be managed within a regulatory framework. The establishment of mechanisms to pre-emptively block financial system risks that could arise during rapid market shifts and protect investors' property rights could also positively impact the resolution of the Korea discount. The success of this reform will depend on how disagreements among stakeholders are resolved during the legislative process and how precise enforcement decrees are drafted.