As the domestic stock market continues its sharp upward trend, the Financial Supervisory Service (FSS) is taking steps to strengthen market risk management in response to short-term overheating and increased leverage investments. The FSS plans to proactively assess liquidity risks stemming from the expansion of comprehensive investment accounts (IMA) and issuance notes by comprehensive financial investment firms, while also significantly shortening the audit cycle and enhancing scrutiny of formal disclosures to restore confidence in the capital markets.
Hwang Seon-oh, Deputy Director of the Capital Markets Division at the FSS, stated during a briefing on capital market issues in Yeouido, Seoul, on May 11, "Rather than being overly optimistic about the overall market based solely on index gains, it is necessary to examine the risks that lie behind this rise. We will continue to pursue institutional improvements to foster a culture of long-term investment and enhance market trust."
KOSPI Surpasses 7000: Caution Advised on Overheating and Short-Term Trading
The KOSPI index has surged 76% over the past year and has gained an additional 74% as of May 7 this year. The amount of idle funds in the market has also increased significantly. As of June 6, investor deposits totaled 130.7 trillion won, and the balance of comprehensive asset management accounts (CMA) reached 112.7 trillion won, bringing the total idle funds in the stock market to approximately 243.4 trillion won. The average daily trading volume of the KOSPI has skyrocketed from 12.4 trillion won last year to 29.6 trillion won from January to April this year.However, the FSS is also paying attention to signs of overheating hidden behind the index's rise. As of April this year, among 948 KOSPI-listed companies, 276 saw their stock prices decline, while 647 out of 1,804 KOSDAQ-listed companies also experienced downward trends. This indicates a growing polarization among stocks despite the overall index increase.
The FSS has identified the expansion of short-term trading by individual investors as a major risk factor. Given that individual investors hold a significant share in the domestic market and that mobile trading infrastructure is well-developed, short-term trading is prevalent. Hwang noted, "Short-term trading not only amplifies market volatility but also accumulates transaction costs that can erode investment returns."
As of April this year, the average turnover rate was 1.48% for the KOSPI and 2.56% for the KOSDAQ, significantly higher than that of the U.S. S&P 500 and Japan's Nikkei. The turnover rate for ETFs reached a record high of 21.58%, with some inverse ETFs seeing turnover rates soar to around 70%.
Regarding the upcoming launch of single-stock leveraged and inverse ETFs expected at the end of this month, the FSS acknowledged the potential for increased volatility. Hwang stated, "We will ensure sufficient investor education before the launch and will continue to monitor trading patterns and trends afterward to devise appropriate responses."
Surge in Margin Loans Raises Concerns Over Forced Liquidation Risks
Concerns have also been raised regarding the rapid increase in margin loans. As of the end of April this year, the proportion of margin loans relative to market capitalization was 0.58%, the lowest level in the past five years, but the absolute amount is rising quickly.The balance of margin loans increased from 27.3 trillion won at the end of last year to 35.7 trillion won by the end of April, a rise of over 8 trillion won. During the market crash in March due to the Middle East conflict, the amount of forced liquidations surged to 108.4 billion won in a single day, which was 22 times the average daily forced liquidation amount from the previous year.
Hwang emphasized, "Margin loans involve borrowed funds for investment, so if stock prices fall, forced liquidations can exacerbate investment losses. Investors need to consider the potential for losses and the risks of forced liquidations and invest within their capacity to absorb losses."
The FSS plans to monitor the risk management status of securities firms and the trends in margin loan balances, and will take preemptive measures to ensure market stability if necessary.
Issuance Notes and IMA Expansion: Managing Liquidity Risks
The FSS also unveiled plans to strengthen risk management in response to the expansion of issuance notes and IMAs by comprehensive financial investment firms. The balance of issuance notes rose from 15.6 trillion won at the end of 2020 to 54.4 trillion won by the end of March this year. The IMA, introduced at the end of last year, has also grown to 2.9 trillion won.The FSS has noted that the short-term funding from issuance notes could lead to maturity mismatch issues if invested in long-term assets like corporate financing. The IMA also has a principal preservation obligation, which could impact the soundness of comprehensive financial investment firms if the underlying assets deteriorate.
Hwang explained, "Comprehensive financial investment firms can raise funds through issuance notes or IMAs, but they must invest a significant portion in corporate financing, where fund recovery is not easy, so they cannot overlook liquidity concerns. While the supply of venture capital is necessary, we must ensure that liquidity crises do not arise from maturity mismatches."
Currently, the FSS mandates a liquidity ratio of over 100% for both issuance notes and IMAs. They are also guiding firms to conduct crisis situation analyses and establish emergency funding plans. In the future, they plan to adjust capital regulations, such as NCR risk values, to facilitate the movement of funds concentrated in real estate toward productive finance.
Hwang stated, "As of the end of March, the liquidity ratio for the seven firms issuing notes was 115%, and the liquidity ratio for the issuance notes themselves was 163%, indicating that there are no significant issues. Please view the current issues as a proactive response to potential challenges."
Audit Cycle Shortened to Detect Accounting Fraud
In the audit sector, the FSS has identified early exit of insolvent companies and enhancing accounting transparency as core tasks. The FSS plans to establish a long-term roadmap to shorten the audit cycle to 10 years for KOSPI firms and 5 years for KOSDAQ firms within this year. Initially, they will apply the 10-year audit cycle to KOSPI 200 companies.Currently, it takes an average of 20 years to audit all listed companies in South Korea. In contrast, the U.S. audits all listed companies every three years, while the U.K. inspects FTSE 350 companies every five years.
The FSS also plans to expand the review targets for companies showing signs of insolvency by over 30% compared to the previous year. They will conduct detailed reviews of companies nearing management designation requirements or facing uncertainties about their continued operations, and will activate a system where the accounting, investigation, and disclosure departments collaborate in response.
Hwang mentioned the possibility of increased incentives for accounting fraud following the tightening of delisting criteria. He stated, "Accounting is fundamentally tied to delisting criteria, so I expect there will be significant attempts to inflate sales figures. We are closely monitoring potential attempts to boost market capitalization in relation to failing to meet market cap requirements."
Strengthening Disclosure to Protect Shareholder Rights
The FSS also announced plans to enhance disclosure reviews and improve the DART electronic disclosure system. They aim to revise disclosure formats and enhance the functionality of the DART system to protect the rights of common shareholders and increase the usability of disclosure information.Although the revised Commercial Act introduced a duty of loyalty to shareholders last year, the FSS believes that some companies are not fully reflecting this intent and are only preparing formal disclosures. In fact, it has been reported that the FSS issued correction orders for disclosures related to organizational restructuring that failed to include specific discussions from special committees or shareholder communication plans.
Hwang stated, "We will strengthen guidance on the duty of loyalty disclosures to help companies understand the intent of the revised Commercial Act and prepare related disclosure documents."
He explained that a recent correction order regarding Hanwha Solutions' securities registration statement for a capital increase falls within the same context. Hwang emphasized, "Our goal is to ensure that sufficient information is provided for investors to make informed investment decisions, including specific details on liquidity risks, potential funding sources beyond capital increases, and the rationale for performance improvement forecasts."
* This article has been translated by AI.
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