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July 6, 2015

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Home » Business » Finance Special

Margin trading cops major blame for market crash

Alarmed by a stock market crash that has wiped about 30 percent off the value of the Shanghai Composite Index in three weeks, Chinese authorities have scrambled to step up rescue efforts.

On Saturday, China’s 21 biggest brokerages said they agreed to set up a 120 billion-yuan fund (US$19.4 billion) to buy the exchange-traded funds of blue-chip shares, starting on Monday. They also pledged not to sell shares from their own portfolios until the Shanghai index goes back to 4,500 points. Listed brokerages pledged to buy back shares of their own companies.

That followed statements from the Shanghai and Shenzhen exchanges over the weekend that they are suspending initial public offerings because of “the recent significant market volatility.”

Financial magazine Caijing reported that the decision to halt IPOs was made at a meeting of the State Council, China’s Cabinet. No sources were identified.

There market nosedive is a grave matter of widespread public concern for the government because more than 80 percent of share investors in China are individuals, not institutional money. In many cases, ordinary people who jumped on the back of the bull this year have had no prior experience with the risks of investing nor familiarity with the wisdom of that old saying: “markets go up by the stairs and down by the elevator.”

“The crash of a highly-leveraged stock market may lead to financial crisis,” said Guan Qingyou, an economist with Minsheng Securities. “It’s urgent for the government to step in and boost the market with real money. In addition to providing liquidity and suspending new-share sales, the government may have to close the market or dramatically change trading rules.”

The Shanghai Composite index dived 12 percent last week as investors ignored a flurry of initiatives announced to stanch relentless selling.

To underscore the magnitude of the collapse, some market comments have noted that the share market losses in China in the past three weeks total more than 10 times the entire GDP of Greece, another country making headlines amid financial turmoil.

Last Wednesday, the China Securities Regulatory Commission said it would ease rules on margin trading, allowing investors to pay back losses in ways other than forced liquidation of shares. It also said it would allow investors whose market assets fall below the 500,000-yuan brokerage minimum to continue trading, and would permit brokerages to roll over margin trading contracts with clients.

Also on Wednesday, the Shanghai and Shenzhen stock exchanges announced about a 30 percent cut in stock transaction fees, and the China Securities Depository and Clearing Co said it would reduce stock transfer fees by about 33 percent, effective August 1.

Margin trading and a flood of IPOs have copped most of the blame. Regulators also said last week they are investigating possible market manipulation.

The market crash follows a dizzying rise in share markets. The Shanghai Composite Index soared more than 150 percent over the past year to a seven-year high of 5,178 points on June 12.

Margin trading, or the ability to buy shares with borrowed money, largely fueled the bull market. The leverage tool was first introduced in China in 2010. When securities regulators suddenly tightened rules on margin financing last month, the panic began.

Who shot the bull?

Lenders have the right to force liquidation of an investment portfolio if a client fails to respond to a margin call by depositing more cash. That leads to a self-fueling cycle of falling prices triggering selling, which in turn drags values down further and creates more margin calls.

The outstanding balance of margin trading rose to a record high of 2.2 trillion yuan on the Shanghai and Shenzhen bourses by the middle of June, a 116 percent surge from the end of last year, data from the exchanges showed.

Margin positions accounted for more than 9 percent of the A-share free-float market capitalization in late June, according to Morgan Stanley. That was higher than any historical comparison on record.

“There was clearly a bubble,” Hong Hao, chief China strategist at Bocom International Holdings Co, wrote in a note. “A rapid decline in margin trading, either from unmet margin calls and thus forced liquidation of margin accounts, or from unwinding margin accounts to take profits, led to the plunge.”

The newly announced easing of rules applies only to margin trading of designated large-cap stocks monitored by the regulatory commission. It doesn’t affect the unregulated “shadow” realm of trusts and online financing channels that lend money for margin trading without limits on investor assets or share selection.

A spokesperson for the China Securities Regulatory Commission said last week that the amount of margin financing through non-brokerage channels was around 500 billion yuan, but analysts estimate that figure to be much higher. Guotai Jun’an Securities estimated the sum could be as much as 2 trillion yuan.

The drama in stock markets came after a flurry of government stimulus measures, including aggressive cuts in interest rates and in the ratio of deposits lenders are required to keep in reserves. It also came after a new plan allowing China’s mainstream endowment pension fund to invest in stocks.

The halt in new IPOs was not unexpected. Initial public offerings were allowed to resume late 2013 after a hiatus declared by regulators to help boost a then-sagging market.

In the first half of this year, there were 190 new listings on the Chinese mainland’s A-share market, raising 147 billion yuan. That was a 265 percent surge in IPOs from a year earlier and a 316 percent increase in fundraising, according to Ernst & Young.

“Investor confidence in China’s equity market has been undermined by dramatic market falls,” said Cao Qing, a fund manager with HSBC Jintrust Fund Management Co. “More stimulus can be expected to be channeled into institutional funds to recover market confidence.”

Will rescue efforts work or is the government simply making a bad situation worse?

Zhu Ning, deputy dean at the Shanghai Advanced Institute of Finance at Shanghai Jiao Tong University, warned that some rescue policies could encourage unbridled speculation and further distort the market.

“Capricious regulatory measures may also lead to disregard for market rules and reduce the effectiveness of supervision,” Zhu said. “They can cause confusion and skew expectations, undermining the market’s role in price discovery.”

Huatai Securities:

New policies to lower transaction and transfer fees signify a firm intention by the regulator to protect the market and encourage trading. The crux of volatile trading was concern over restricted margin trading, which had somewhat demolished market confidence. The policies had been a suitable remedy to restore rationality in the market. If daily transactions are set at a level of 800 billion yuan, the lower fees would save investors more than 60 billion yuan a year. The market will gradually return to normal, and financial shares should prove lucrative for investors.

Industrial Securities:

After recent ups and downs, a bullish market will emerge in which investors will pay more attention to shares with less investment risk, such as railway, power equipment, clean energy and finance stocks. There are also solid stocks that reflect the nation’s larger economic concepts, such as the Internet, environmental protection, sports, “Made in China 2025” and new energy cars.

Minsheng Securities:

In a long view, the market will see a different trend of shares not rising or falling across the board. Certain sectors that didn't rise as much in previous bull markets, such as finance, food and drinks, will be more popular among investors. Those related to the reform in China’s state-owned enterprises will also prove lucrative, such as stocks related to “Made in China 2025,” the military industry and environmental protection.

Galaxy Securities:

Surging blue chips in the previous bull market will be linked in the future to their sector’s performance in the real economy rather than to speculation. Investors are advised to look at shares in three key sectors: SOE-related reform, the “Made in China 2025” concept and pharmaceuticals.

Citic Securities:

Restricted margin financing was a key factor in the volatile, downward market. The rally on June 30 suggested it was positive sentiment on margin trading that had led to the market’s rise. The hasty policies that came out on the night of July 1 signified a strong stance by the regulator in maintaining a positive market. Blue chips that rebound will be those carrying some big “national label,” such as those related to SOE reform concept.


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