Repeated Warnings of CFD Side Effects... Doubts Over Effectiveness of Expected Improvements Such as Margin Rate Increase

Financial Authorities Shift from 'Reviewing Improvements' to 'Implementing Improvements' Amid Worsening Public Opinion
"If Margin Requirements Increase, Securities Firms Expected to Propose Commission Reductions"
Need to Examine Whether CFDs Should Be Included in Investor Credit Limits

The financial authorities are deeply concerned about the Contract for Difference (CFD) system, which is cited as the epicenter of the Soci?t? G?n?rale (SG) Securities-triggered crash. Initially, the stance was to review any necessary improvements to the CFD system after concluding the stock manipulation investigation. However, as distrust related to CFDs has grown uncontrollably, the authorities have shifted direction to begin system enhancements immediately. This shift comes amid criticism that they failed to detect any signs of stock manipulation until media reports and investigation requests surfaced, and accusations of neglecting improvements to the CFD system, which was left in a statistical and supervisory blind spot. Nonetheless, there is criticism that the leading proposed improvements may not be effective in preventing CFD accounts from being exploited for criminal purposes.

Shift in Position to 'Rapid Review of CFD System'

According to the financial authorities, the Financial Services Commission (FSC) plans to collaborate with the Financial Supervisory Service (FSS) and Korea Exchange (KRX) to propose improvements to the CFD system. Kim So-young, Vice Chairman of the FSC, stated, "Although the investigation is ongoing, we will prioritize reviewing the recently raised needs for system improvements in CFDs and actively and promptly implement enhancements, with further improvements to follow based on the investigation results."

Initially, the authorities believed that the current incident was unlikely to be primarily caused by defects in the CFD system itself. Their position was to first examine whether the incident resulted from unfair trading in individual stocks. However, public criticism directed at the authorities intensified, which is interpreted as causing them to feel pressured. In particular, the Korea Stock Investors Association strongly condemned the situation, stating, "The essence of this CFD incident is that while a small number of investors profit by manipulating the market through loopholes, the entire market bears the resulting damage and harm."

The Korea Stock Investors Association pointed out the following issues with CFDs: ▲ use as a loophole for tax avoidance on stock transfer taxes ▲ purchases recorded as foreign investors, enabling identity laundering ▲ evasion of 5% shareholding disclosure due to non-ownership trading characteristics ▲ vulnerability to forced liquidation (margin call) ▲ potential misuse for anonymous stock price manipulation ▲ market disruption through blind short selling. Jeong Ui-jung, the association’s representative, said, "This incident is close to a predicted disaster, as it occurred after the financial authorities relaxed the qualification requirements for CFD professional investors to 50 million won in 2019, leading to an eightfold increase in CFD investors over three years, which was exploited by manipulative forces. The CFD system should be suspended until the capital market reaches an advanced country level."

Leverage, Anonymity, Forced Liquidation

CFDs are over-the-counter derivatives where investors do not directly own the underlying assets such as stocks but settle only the price difference. For example, if a stock priced at 50,000 won rises to 60,000 won, an investor must pay 50,000 won to buy the stock to earn 10,000 won. However, with CFDs, which have a maximum leverage ratio of 2.5 times, the investor can earn 10,000 won by paying only the margin, which is 40% of 50,000 won (20,000 won).

The CFD structure is prone to abuse due to anonymity. In the case of margin loans, although the leverage ratio is the same, investors must buy stocks under their own names, ensuring transparency. CFDs differ in that domestic securities firms place orders on the exchange through foreign securities firms. The account holder does not execute orders directly. The supply and demand notation appears as foreign investors. This explains why the related trading volume was recorded under SG Securities’ name in this case. Investors can exploit anonymity to engage in various unfair trading practices. Unlike margin loans, CFDs have no maturity. This is why the group manipulating the prices could steadily control the eight stocks hitting the lower limit for three years.

Another concern is that forced liquidation, which can maximize market volatility, occurs immediately. Forced liquidation happens when the stock price falls below a certain level and the investor fails to add margin, causing the securities firm to forcibly sell the stocks. In margin loans, investors are given two days to replenish margin, but in CFDs, forced liquidation happens in real time. Lee Hyo-seop, a researcher at the Korea Capital Market Institute, explained, "The greater the market volatility, the more forced liquidations occur in CFDs, causing significant losses to individual investors. Especially if forced liquidations suddenly flood large-cap stocks included in indices like KOSPI 200, it can shake the index and cause index distortion."

Repeated Past Warnings Ignored...

Concerns about CFDs have been raised multiple times in the market. Jeong Ui-jung said, "Voices warning about CFD side effects emerged even when the KOSPI fell to 1,457 during the COVID-19 pandemic in 2020, and two years ago during the 'Bill Hwang' incident, there was public opinion that CFDs could be a stock market time bomb. Despite these two alarms, fundamental measures were not established, leading to this incident." The 'Bill Hwang' incident refers to the 2021 case in the U.S. where Korean-American fund manager Bill Hwang invested about $50 billion (approximately 63 trillion won), five times his assets, in stocks through CFDs and other derivatives, resulting in bankruptcy.

Hong Sung-guk, a Democratic Party lawmaker and former CEO of Daewoo Securities, pointed out at the 2021 Financial Supervisory Service audit that CFDs, as a high-leverage trading tool, could trigger forced liquidations and exacerbate market turmoil. Lee Yong-woo, a Democratic Party lawmaker and former CEO of Kakao Bank, also warned about excessive leverage in CFDs and the risks of forced liquidation. Lee said, "CFDs carry a high risk of forced liquidation in a sharp market downturn, and the chain reaction from forced liquidations can adversely affect the entire market, making risk management especially important."

Earlier in 2019, Democratic Party lawmaker Lee Hak-young pointed out, "CFD trading is increasing, but it is a statistical and supervisory blind spot, and since it may allow evasion of large stockholding or short-selling reporting obligations, system improvements are urgent."

Negligent Risk Management... Controversy Over Effectiveness of Measures

The financial authorities face strong criticism for neglecting risk management despite expanding the CFD market size. In particular, many point out that the relaxation of professional investor qualification requirements for CFD investment contributed to the scale of this incident. In 2019, to revitalize the CFD market, the FSC changed the requirements from a financial investment product balance of 500 million won, annual income of 100 million won or more, or assets of 1 billion won or more, to a financial investment product balance of 50 million won, annual income of 100 million won or more, or assets of 500 million won or more, or possessing expertise. According to Lee Yong-woo’s office, the number of registered individual professional investors surged from 3,300 in 2019 to 11,626 in 2020 and 24,365 in 2021. The CFD account balance also surged from 800 billion won in 2019 to 4.7 trillion won in 2020 and 5.4 trillion won in 2021.

The market expects that the personal professional investor requirements will be strengthened as a CFD system improvement measure. However, since the financial authorities emphasize the importance of investors who can boldly supply necessary funds by recognizing the growth potential of innovative companies to boost economic vitality, the strengthening is expected to be limited.

There are doubts about the effectiveness of CFD improvement measures. Apart from maturity, forced liquidation timing, and disclosure enhancement, there are few areas to address. Leading proposals include ▲ raising the minimum CFD margin ratio (currently 40%) ▲ strengthening professional investor qualification requirements ▲ introducing CFD maturity and balance disclosure.

During the 'Bill Hwang' incident, the FSS raised the minimum margin rate from 10% to 40% in a 2021 administrative guidance. Despite this, CFDs were cited as the epicenter of the SG-triggered crash, indicating that raising the margin had limited effect. A financial investment industry insider said, "Even if the margin is raised, the effectiveness in preventing criminal misuse will be limited. Securities firms manage risk by setting their own limits within the legal credit provision limit of 100% of their capital, so in-depth improvements such as including CFDs in investor credit provision limits need to be proposed." Another insider predicted, "If the margin is raised, securities firms may lower fees to prevent customer attrition. Once the current issue settles, fee competition in the securities industry is expected to intensify."

This content was produced with the assistance of AI translation services.