The Financial Services Commission announced that revisions to the Enforcement Decree of the Financial Investment Services and Capital Markets Act (FSCMA) allowing the introduction of single-stock exchange-traded funds (ETFs) have been approved by the government at the cabinet meeting held on April 21. The revised rules will upgrade the rules on the domestic ETF market and help to close the regulatory gap existing between the domestically listed ETFs and the overseas listed ETFs.

The revised rules will be promulgated and become effective from April 28.

Key Revision Details

a) Allowing the introduction of single-stock ETFs (same rules to be applied on ETNs)

In major overseas markets, such as the U.S. and Hong Kong, there are single-stock ETFs that are available for Korean investors to trade via the mobile applications of domestic securities firms.

However, in the domestic market, introducing single-stock ETFs or single-stock ETNs has not been possible thus far due to the dispersed investment rule requiring ETFs to have at least ten underlying items with maximum 30 percent limit on each item. This has led to the problem of the domestic market environment not being able to sufficiently meet investors’ demands for diverse types of ETF investment. Against this backdrop, the FSC sought regulatory reforms to make domestic rules more consistent with global standards to facilitate more inflow of investments from overseas, while enhancing protections and convenience for investors to help prevent the outflow of investment capital.

Under the revised rules, introducing single-stock ETFs tracking blue-chip stocks will be allowed in the domestic market, and the maximum level of exposure allowed will be restricted to 200 percent (2x leverage).

The criteria for underlying stock items and product types will be prescribed under the subordinate rules as follows. Underlying stock items need to meet the following criteria—(a) a minimum market cap ratio of 10 percent, (b) a minimum trading volume of 5 percent, (c) an investment grade rating, and (d) a minimum derivatives trading volume of 1 percent. For product types, there will be single-stock 2x leveraged (inverse) ETFs and single-stock covered call ETFs.

A revision to the Korea Exchange (KRX) regulations has also established a regulatory ground to allow the listing of single-stock ETFs and ETNs tracking blue-chip stocks in the domestic market. In the case that underlying stocks become subject to trading suspension or delisting, the single-stock ETFs and ETNs tracking them will also be subject to trading suspension or delisting.

b) Facilitating the development of diverse types of ETFs including covered call ETFs

There has been relevant rules change made to the KRX regulations to allow the development of diverse types of ETFs. Previously, only index options were allowed for weekly options products, but the revised rules will allow the introduction of single-stock weekly options and ETF weekly options. In this regard, single-stock weekly options and ETF weekly options will be listed for the first time on June 29 and in the second half of this year, respectively.

Additionally, weekly options tracking KOSPI200 and KOSDAQ150 indices with expirations taking place on a daily basis (Monday through Friday) as well as ETF monthly options products will become listed for the first time in the second half of this year. With the availability of diverse types of ETF products including covered call ETFs, which guarantee regular dividends based on domestically listed assets, investors will be able to employ diverse investment strategies and benefit from more investment options.

Strengthening Investor Protection

Considering the higher level of risk involved in single-stock leveraged ETFs and ETNs, the Korea Financial Investment Association (KOFIA) has updated its own rules to ensure an enhanced level of investor protection measures.

a) Requiring enhanced prior learning session and base deposit rate

Previously, investing in domestically or overseas listed leveraged ETFs and ETNs required an hour of prior learning session. To be eligible to invest in the newly introduced single-stock leveraged ETFs and ETNs, prospective investors will be required to take an additional hour of intensive learning session prior to investing (the prior intensive learning session will become available from April 28).

The prior intensive learning session is structured in ways to make sure that investors are clearly aware of the high-risk characteristics of single-stock ETFs, with the provision of information about negative compounding effect, premium/discount rate, etc., as well as a quiz and a checklist for investors.

This prior learning requirement will apply to both domestically and overseas listed single-stock leveraged ETFs and ETNs. Additionally, the base deposit rate of KRW10 million required for investing in domestically listed leveraged ETFs and ETNs will also apply to investing in overseas listed leveraged ETFs and ETNs (to be effective for new investors) to help resolve the regulatory inconsistency and strengthen protection for investors.

b) Ensuring clear description of products to prevent confusion

To make sure that investors clearly understand the fact that single-stock leveraged ETFs are not designed for dispersed investment, these products will be required to clearly display the words “single-stock,” “leverage,” or “inverse”—instead of “ETF”—on their products description.

c) Other investor protection measures

Since the newly introduced single-stock ETFs carry higher risks in comparison to the ETFs tracking multiple underlying assets, authorities will make sure to thoroughly examine whether the risk factors and potential loss are duly included in the securities registration.

Further Plan

The revised rules will be promulgated and become effective from April 28. Single-stock leveraged ETFs will then become listed for trading from as early as May 22 after going through the securities registration and listing review process.

Single-stock leveraged ETFs have unique price structures and risk factors. Thus, investors are recommended to practice caution and invest in single-stock leveraged ETFs within their own risk appetite.

* Please refer to the attached PDF for details.