China stocks: expect less volatility in 2016 amid slower growth in margin financing

Mainland authorities likely to keep tighter caps on the ability of investors to use borrowed money to buy securities.

PUBLISHED : Tuesday, 29 December, 2015, 5:01pm
UPDATED : Tuesday, 29 December, 2015, 5:01pm

Did China’s tightening of margin financing help trigger the rout in mainland Chinese stocks earlier this year?

The jury is still out on the actual causes of the market turmoil that started in June, but a clampdown on official and unofficial channels of credit coincided with the U-turn in China shares.

Throughout the first half of the year, mainland authorities, concerned about irrational exuberance in China stocks, unveiled a successive tightening of rules that enable investors to use borrowed money to buy securities.

The process began in early January, when the China Securities Regulatory Commission, increased the minimum threshold for margin trading accounts to 500,000 yuan (HK$597,000) from zero.

In spite of these efforts, China’s margin-financing balance ballooned to 2.27 trillion yuan as of June 16, more that double what it was at the start of the year. Around the same time, the Shanghai Composite reached its highest level in seven years.

It’s not clear what administrative measure tipped the balance, but at some point investors rapidly cut back their leveraged bets, triggering a panic sell-off and leading to a months-long free fall in mainland markets.

“The growth in margin businesses is not unlimited, as markets tend to become unstable once the margin-financing balance exceeds its reasonable limits, such as 3.5 per cent of free-float market cap,” said Jupiter Zheng, an analyst from Hong Kong-based BOCOM International.

“The market crash since June is largely due to a rapid deleveraging of the markets, through both official and unofficial channels,” he added.

As the Shanghai benchmark tumbled 40 per cent from its June peak within two months, the margin-financing balance also shrank rapidly. The outstanding balance of margin loans and short-selling bottomed at 904 billion yuan as of September 30, or about 60 per cent below its level in June.

The imploding stock market prompted Beijing to roll out unprecedented rescue measures, including limits on short selling, setting up an emergency funds to purchase stocks and banning major stock holders from selling shares.

As of December 23, the Shanghai Composite Index was up 20 per cent in the fourth quarter.

Coinciding with this rise is a gradual recovery in the margin-financing balance, which now stands about equal to its level in February. The current daily margin buying amount accounts for 10 per cent of the average daily market turnover, according to calculations by Deutsche Bank in a December 21 research note.

Still, its likely that new controls will help to foster a more gradual rate of growth in margin financing in the year ahead.

In November, the Shanghai and Shenzhen stock exchanges announced they will cut by half the amount that retail investors can borrow to purchase stocks, in a move to rein in speculative trading and prevent systemic risks.

The new rules indicated that Beijing has “learnt lessons from the market correction in June” and hope to contain risks from margin businesses, J.P. Morgan analysts said in a recent research note.

Xu Fei, an analyst for Sinolink Securities, said the policy is mainly aimed at “adjusting the pace of the markets and prompting a slow and long bull.”

BOCOM’s Zheng agrees that authorities are likely seeking to foster an alternative path for China’s markets.

“The authorities don’t want to kill a market rally, but they hope to see a healthy stock market with reasonable leverage, rather than a rapid increase in margin lending which may exacerbate the short-term volatility and pose systemic risks to the financing system,” Zheng said.

Meanwhile, Credit Suisse analysts also expected the market liquidity to remain positive in 2016.

The margin-lending business may benefit from newly-added “qualified investors” and the regulator’s crackdown on illegal OTC (over-the-counter) fund-matching, Charles Zhou and Arjan van Veen, analysts from the Swiss firm, said in a 2016 outlook research note.

China has recently relaxed its control on foreign investors seeking to invest in the country’s capital markets. Earlier this month the foreign exchange watchdog loosened the rules on the Qualified Foreign Institutional Investors scheme, making it easier for foreign investors to transfer funds between selected investment products.