[Aftermath of SG] 'Invest 4 million won for 10 million won worth'... No answer for difference settlement trading in a falling market

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In the wake of a series of limit-down incidents triggered by the French securities firm Soci?t? G?n?rale (SG), it has been revealed that stock manipulation groups were involved, with Contract for Difference (CFD) trading identified as a tool used in the crime. Although the exact cause of this week’s stock price crash has not been clearly established, it appears that the manipulators exploited loopholes in CFD trading for illicit purposes. CFD trading itself is not illegal; it is a common product traded in the over-the-counter derivatives market. The Financial Services Commission and the Financial Supervisory Service have focused on the connection between CFD trading and stock manipulation tactics and have launched a full-scale investigation. They also plan to conduct a joint investigation to improve the CFD system.

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CFD is an over-the-counter derivative product that allows investment without owning the actual stocks. If the professional investor requirements are met, investors can leverage up to 2.5 times (margin rate 40~100%) the cash they hold as margin. For example, to buy 1,000 shares of a stock priced at 10,000 KRW per share, 10 million KRW (1,000 shares × 10,000 KRW) is needed, but using a CFD with a 40% margin rate, an investor can enter the market with only 4 million KRW, which is 40% of the total settlement amount. The remaining 6 million KRW can be borrowed from the securities firm.

At this time, the securities firm charges the investor a transaction fee and interest on the borrowed money. Transaction fees vary for buying and selling, as well as between foreign and domestic stocks. They are known to be higher than regular cash stock trading fees (up to 0.7%). However, after the relaxation of professional investor qualification requirements in 2019 led to increased participation by individual investors, some securities firms offered fees below 0.1%. Kyobo Securities first introduced CFDs in 2015. Currently, a total of 13 securities firms provide CFD trading.

Although CFDs appear similar to general leveraged investments like margin trading, they are derivatives traded in the over-the-counter market and are therefore only open to professional investors. To qualify, one must meet the essential condition of maintaining an average monthly balance of at least 50 million KRW over one year and satisfy at least one of the following three criteria: an individual annual income of 100 million KRW or a combined spousal income of 150 million KRW, possession of financial or special qualifications, or net assets excluding liabilities of at least 500 million KRW.

Interest is calculated based on the purchase amount. Unlike margin loans where interest is charged on the borrowed amount from the securities firm, CFDs differ. The lowest interest fee among securities firms is in the 5% range. The larger the purchase amount, the higher the interest fee. CFDs have no maturity. Margin loans have a fixed period, with interest rates increasing the longer the loan period. However, CFDs allow investment without forced liquidation and regardless of duration as long as the account margin ratio is maintained.

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Market insiders could point to CFD accounts as the method used in the limit-down incident triggered by SG Securities due to the close connection with forced liquidation volumes. On the 24th, sell orders poured into the SG Securities desk for eight stocks (Daesung Holdings, Samchully, Seongwang, Seoul City Gas, Sebang, Daideita, Harim Holdings, Daol Investment & Securities). Typically, forced liquidations by foreign securities firms occur immediately after market opening. Although SG Securities is not very active in domestic stock trading, it is a major securities firm providing prime brokerage services (PBS) in the CFD market, which raised suspicion of forced liquidation of CFD accounts.

Generally, domestic CFD trading is conducted through back-to-back contracts with foreign securities firms. When a domestic securities firm receives an order from an investor, a foreign securities firm with a total return swap (TRS) contract executes the actual stock trades and provides PBS. In conclusion, trades occur through foreign desks. Based on the facts revealed so far, a rift within the manipulation group led to a defector, causing the stock price to fall. The securities firm requested additional margin deposits based on closing prices, but the margin was not met, leading to forced liquidation.

The problem is not limited to losses by professional investors who engaged in leveraged investments. CFDs are vulnerable in falling markets. If margin requirements are not met, forced liquidation is triggered, affecting other stocks held by the CFD investor. This can lead to a chain reaction of forced liquidations. In such cases, general investors who had invested in those stocks may suffer significant losses. Ultimately, this triggers volatility across the stock market and drags down indices. In fact, the KOSPI, which had surpassed 2,500 points last week, fell to the 2,480 level on the 26th, and the KOSDAQ index, which had risen to 900 points, dropped over 7% to the 830 level.

Additionally, due to the nature of CFD trades being settled through foreign entities, there is a high possibility of 'supply-demand distortion.' The eight stocks involved in this incident had shown long-term upward trends with little volatility over 1 to 3 years. Before falling to the price limit on the 24th, Seongwang recorded a 1,100% return over 3 years, Samchully 360% over 1 year, and Daideita about 300%. Given that these companies are mid-sized enterprises and foreign securities firms consistently appeared as buying desks, general investors likely perceived them as 'stable stocks to buy.' The opaque disclosure typical of over-the-counter derivatives triggered 'blind investment.' A Financial Supervisory Service official said, “This incident confirmed once again that individual investors can suffer losses due to information asymmetry,” adding, “We will review the matter with the Financial Services Commission and include related improvements in the reform plan.”

Criticism has also been raised that securities firms failed to properly manage CFD account limits, which exacerbated the situation. Following the relaxation of professional investor requirements in 2019, the CFD trading volume more than doubled from 30 trillion KRW in 2020 to 70 trillion KRW in 2021. Accordingly, the Financial Supervisory Service last year 'recommended' securities firms providing CFD services to set individual and stock-specific limits to enhance market soundness.

Among domestic securities firms, only Meritz Securities has set both individual and stock-specific limits. For example, if the maximum investment per person is 800 million KRW and the stock-specific limit is 50%, the maximum amount that can be invested in a single stock through CFDs is about 400 million KRW. However, this is a non-binding recommendation, and it is difficult to find securities firms offering CFDs that have set such limits. A financial investment industry insider said, “The core issue in this problem is that professional investors could place unlimited CFDs on specific stocks,” adding, “Even though the Financial Supervisory Service issued recommendations, securities firms that did not manage the market to secure profitability also bear responsibility for the incident.”

The financial investment industry expects that financial authorities will propose institutional improvements such as strengthening the professional investor qualification requirements, which were lowered to supply venture capital through CFDs, setting limits on accounts, and expanding the scope of information disclosure. Some express concern that the CFD market might shrink due to its association with manipulation groups. There is an argument that the root cause of this incident is not the CFD system itself but the stock manipulation groups abusing the CFD system.

Market experts agree on the need for institutional improvements but emphasize that the market should not shrink as a result. Hwang Se-woon, a research fellow at the Korea Capital Market Institute, said, “The CFD market was opened not only to existing institutions but also to individuals. Compared to overseas markets, domestic investors use CFDs for short selling and tax saving,” adding, “The resolution of this incident should focus on improving the system rather than reducing the scale of CFD trading.”

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