Will the 2023 Stock Crash Repeat? South Korean Retail Investors Flock to High-Risk 'Contracts for Difference'

Recent data shows that well-funded South Korean retail investors are pouring back into leveraged instruments—'contracts for difference' (CFDs)—that previously caused massive losses. As stock markets experience sharp volatility, there are growing concerns that these leveraged bets could face concentrated liquidations.

According to Bloomberg, data from the Korea Financial Investment Association shows that CFD open positions have surged nearly two-thirds year-on-year, reaching approximately 3.3 trillion Korean won (about $22 billion) as of Monday. South Korea still allows investors whose accounts meet certain asset thresholds to trade so-called contracts for difference, while the U.S. bans CFD trading for general retail investors.

CFDs are popular due to their leverage effect. Investors can gain exposure up to 2.5 times the underlying risk by depositing just 40% of the total exposure value. However, CFDs were restricted in South Korea in 2023 after contributing to market instability, and their resurgence now comes at a particularly sensitive time.

Leveraged ETFs linked to chip stocks have already exacerbated market volatility, prompting regulators to temporarily halt approvals for new single-stock leveraged ETFs.

Natasha Sibley, portfolio manager at Janus Henderson's Multi-Alternative Investments team, warns that the higher the leverage in the financial system, the greater the risk. If other investors who bought South Korean chip stocks via CFDs or margin loans face forced liquidations, it will inevitably impact stock prices and amplify market volatility.

The market impact of CFDs is similar to that of leveraged ETFs. The investor's counterparty—typically a bank—must hedge its own exposure, often by holding the corresponding physical stocks. Once a client's CFD position is forcibly liquidated, the counterparty must sell the related stocks, further accelerating market declines. This effect is similar to the selling pressure caused by daily rebalancing in leveraged ETFs.

The key difference is that ETF rebalancing occurs daily, while forced selling from CFD liquidations happens only during margin calls.

Maxence Visseau, Chief Investment Officer at Dubai-based Arkevium Capital, says the market impact of CFDs is often 'more concentrated and more intense.'