South Korean financial authorities on Monday announced an overhaul on contract for difference (CFD) trading that is blamed for triggering the recent stock plunge following massive sell orders through SG Securities Co.

The Financial Services Commission (FSC), the Financial Supervisory Service (FSS), Korea Exchange, and the Korea Financial Investment Association held a meeting last week and discussed measures to complement CFD regulations.

CFDs are a type of over-the-counter (OTC) trading that allows traders to invest using leverage with a certain amount of deposit. They have been accused of being vulnerable to market manipulation.

Although as much as 96.5 percent of real holders are individuals, CFD accounts have been delivered as part of institutional trading. While causing confusion around the origin of the transactions, the faulty sector has also been vulnerable to unfair transactions.

In addition, CFD trading is similar to margin trading in that it allows traders for leveraged transactions with a 40 percent deposit of the full value. CFD accounts, however, are not included in the upper threshold of credit offering for securities firms.

Under new regulations, trading entities will be categorized as real identities.

“The financial authorities will overhaul regulations on CFD trading so that investors can correctly identify information about the transactions, such as who the real investors of the CFD trading are and how high the liquidation risks that these CFD transactions bear are,” said FSC Vice Chairman Kim So-young.

“They will be able to make prudent investment decisions,” he added.



The new regulations are designed to resolve regulatory arbitrage with respect to credit financing. To that end, the financial authorities will require brokerage firms to manage CFD accounts as part of their credit offering and put restrictions on the derivatives, especially low-liquidity stocks.

“CFDs have not been subject to strict regulations on credit offering and other risk management because they are derivatives,” said an unnamed source from the financial authority. “That led to a surge in CFD transactions, causing higher volatility, especially in low-liquidity products, and disruptions in the soundness of brokers.”

The financial authorities also plan to bolster requirements for CFD transactions in the same way that they regulate short-selling positions in terms of balance disclosure.

The authorities also plan to make the criteria to qualify as a professional investor more stringent. Authentication for professional investors, which has been remote, will now take place face-to-face. “The current contact-free authentication has mistakenly made it for investors to recognize the risks of CFD trading,” said an official from the FSC. “Yet, face calls for authentication will be kept in place.”

Brokers will also need to verify the qualification of professional investors every two years.

Professional investors will not be allowed for CFDs and other OTC products if they have sufficient experience in high-risk investments such as stocks and OTC products.

The financial authorities estimate that only 22 percent of the current professional investors will become eligible for OTC transactions under the new rules.

The regulators advised investors to refrain from CFD trading and opening accounts for the next 3 months until the new regulations come into effect in August.

By Kim Myung-hwan and Han Yubin

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