Forceful Actions by China to Regulate Markets Send Shares Plunging

JANUARY 19, 2015 5:24 AM

Updated, 7:24 p.m. |
HONG KONG — Chinese regulators are making stock market investors nervous.

After officials moved to rein in risky trading, stocks in Shanghai plunged 7.7 percent on Monday, the largest one-day sell-off since the 2008 financial crisis.

Regulators, in part, are taking aim at so-called margin accounts, in which investors borrow money to buy shares.

Such lending has played a big role in the phenomenal rise of the Chinese stock market, the world’s best-performing market last year. Before the rout on Monday, the benchmark Shanghai Composite Index was up 38 percent in the last three months.

But the added leverage also amplifies risk, meaning a boom can quickly turn to bust. Outstanding margin financing had more than doubled in the last six months, recently exceeding one trillion renminbi, or about $161 billion.

To help keep that debt in check, the China Securities Regulatory Commission on Friday temporarily banned new margin financing at three of China’s biggest brokerage firms. After an investigation into 45 firms, the regulator said that the state-owned brokers — Citic Securities, Haitong Securities and Guotai Junan Securities — violated rules by extending margin financing and securities lending to a large number of clients beyond the contracted term, usually six months.

Market Plunge

After rising 65 percent since July 1, the Shanghai Composite Index fell 7.7 percent on Monday.

The regulator “worries that some brokers have not been fully compliant in their margin finance operations, which may lead to substantial losses of their clients, and brokers themselves, in case of a market correction,” said Leon Qi, an analyst at Daiwa Capital Markets. “Hence it ‘engineered’ a market correction.”

Separately, China’s banking regulator moved to tighten oversight of so-called entrusted loans, a rapidly growing segment of the shadow banking industry. There are concerns that such loans have been used to invest in equities, helping to further fuel the frenzy.

A spokesman for China’s securities regulator denied in a statement that the moves were intended to “push down the stock market.” Instead, the spokesman, Deng Ge, emphasized the need “to protect investors’ rights.” “Don’t overinterpret the stock market,” he said.

The actions dovetail with China’s broader push to manage its economic slowdown.

In an effort to stimulate growth, the central bank — the People’s Bank of China — recently cut interest rates and loosened lending restrictions on banks. Analysts said Beijing’s overall goal was to ensure that new liquidity created by the easing of monetary policy found its way into productive sectors of the economy, where it can help create jobs and does not just get plowed into the stock market.

“The stock market fever has made it difficult for the People’s Bank of China to further loosen monetary policy,” said Mr. Qi, of Daiwa. The securities regulator, he said, “is helping to cool the sentiment on stocks, with the aim that some of the incremental liquidity will go to the real economy.”

Containing risk is a major priority for China’s top securities regulator, Xiao Gang. He showed no sign of concern about the tumult as he addressed a financial forum on Monday in Hong Kong.

Mr. Xiao did not specifically refer to Monday’s market sell-off. Instead, he praised a new pilot program linking the Shanghai and Hong Kong stock exchanges as “a very important innovation.” It cracks open the door to China’s still largely closed capital account, he said, in a way that “the risk can be controlled.”

But he faces a delicate task in dealing with the excesses of the stock market. While he must aim to let some of the steam out, he must also avoid a runaway sell-off that could create painful losses.

It is a challenge, given the amount of leverage already in the system. Frances Feng, an analyst at Credit Suisse, wrote on Monday in a research note that margin financing accounted for around 18 percent of the average daily trading volume in China, more than double what it was a year ago.

The rally, too, looks increasingly precarious. Trading volume in Shanghai peaked on Dec. 9, when shares worth 77 billion renminbi changed hands. The current five-day trading volume is less than a third of that level, at around 22 billion renminbi, signaling that shares could fall from their current levels.

At the same time, the pace of new investors piling into the market has slowed. The number of new trading accounts opened on the Shanghai and Shenzhen stock exchanges declined to 550,000 in the trading week that ended Jan. 9, down from a peak of nearly 900,000 the week that ended Dec. 12.

The suspension of new margin financing accounts is likely have a significant effect on the brokerage firms, which had been ramping up such activity in recent months. Several, including Citic and Haitong, had taken advantage of their own surging share prices to announce new offerings of stock, the proceeds of which would partly have been used to invest further in margin financing. Shares in Citic Securities and Haitong Securities both fell by 16.5 percent on Monday in Hong Kong.

In an announcement late Sunday, Citic Securities said it would take a number of steps to reduce risk in its existing margin finance business. Among them: raising the minimum amount of assets a client must have to secure such financing, to 500,000 renminbi from 300,000 renminbi.

“The company will seriously implement the corrective measures, fully review its existing business process and systems and rules, and conduct business in strict compliance with existing business rules,” Wang Dongming, the chairman of Citic Securities, said in the announcement.