South Korea’s FSC Didn’t Run Stress Test Before Launching Single-Stock Leveraged ETFs

South Korea’s Financial Services Commission told a parliamentary committee last week that it had reviewed the risks before allowing single-stock leveraged exchange-traded funds to launch. Documents later submitted to lawmakers show no actual stress test was conducted.

Materials the FSC provided on Aug. 3 to the office of Park Sung-hoon, a lawmaker with the ruling People Power Party, showed the regulator did not carry out a stress test either internally or through an outside institution before the products were introduced. Stress tests are used to identify vulnerabilities in financial products or systems under extreme scenarios such as a sharp drop in share prices.

The finding conflicts with remarks by FSC Chairman Lee Eog-won at a full meeting of the National Assembly’s Political Affairs Committee on July 29. After Park questioned the rationale for introducing the products and asked for materials showing whether a risk analysis process, including stress testing, had taken place, Lee replied that the products had undergone a full review and promised to submit the documents.

The materials the FSC sent to Park’s office consisted of a 2024 Korea Capital Market Institute report on factors behind leveraged and inverse ETF investment performance, data on rebalancing volumes by leverage ratio, and market capitalization and trading value statistics as of March for stocks including Samsung Electronics and SK Hynix. They did not include specific shock scenarios based on assumptions such as a steep decline in Samsung Electronics or SK Hynix shares.

The FSC also warned that single-stock leveraged ETFs carry a risk of principal loss. Leveraged ETFs rebalance daily by buying and selling shares to maintain a target return multiple, and losses can accumulate in that process when stock-price volatility is high. The regulator said single-stock products are far more volatile than standard leveraged ETFs, carry higher loss risk and could exacerbate sharp swings in share prices during rebalancing.

The FSC added that excessively frequent trading can raise transaction costs and lead to errors in judgment, worsening returns for retail investors. It said investors need a clear understanding of leveraged ETFs’ characteristics and that policy efforts are needed to curb unnecessary overtrading. The episode is likely to fuel criticism that the authorities recognized the need for such safeguards while failing to adequately test the vulnerabilities of a high-risk product.

Esther Lee, Hankyung.com reporter esther@hankyung.com