Equity pledging the biggest landmine for A-share markets
Equity collateral, unregulated investments and rising redemption of wealth management products weighing on mainland China’s battered markets
A 13-month low for the mainland China’s benchmark stock index is not the end of the world but A shares could go down much further to a scary low as financial institutions close positions backed by equity collateral and withdraw unregulated investments from the markets, analysts say.
The Shanghai Composite Index fell to a 13-month low on Tuesday, before losing another 0.52 per cent on Wednesday to close at 2,735.56. The tech-heavy ChiNext Index, comprising private companies with growth stories and sky high valuations, touched a four-month low.
Gao Ting, a strategist with UBS, said concerns over stock rights pledging had been triggered by the broad market fall and related selling pressure, including forced liquidation by pledgers, could increase significantly and accelerate the market slump.
Four companies filed trading suspension announcements to the Shenzhen Stock Exchange on Wednesday morning, saying their share prices had declined to “warning levels”, and major shareholders needed to top up their margin accounts, or otherwise their equities would be sold out.
Among them, Fujian Guanfu Modern Household Wares, a company focused on home and office furnishings, said the controlling shareholders had pledged the entire 34.6 per cent stake they owned. Their pledger had told them to top up the account, as share prices had declined to warning levels.
“The shareholders will take active measures to top up the account, and make sure the equity structure of the company is stable,” the filing said, adding that the company would resume trading in five trading days.
Gao said in a note on Wednesday morning that using two different calculating models, 155 or 214 companies had seen their share prices hit the warning or position-closing levels by Tuesday’s close. The market cap of these stocks accounts for 3 per cent to 5 per cent of the A-share floating market capitalisation.
“If the market falls a further 10 per cent, the floating market cap of the stocks hitting the warning/position-closing levels could increase to 12.6 per cent,” Gao wrote in the note.
Eric Wu, a hedge fund analyst based in Shanghai, said he considered equity pledges “the biggest landmine” in the A-share markets today.
“The margin call is threatening. When forced liquidation starts, the market will fall with a scary speed. I don’t know where the bottom will be,” he said.
In a note issued on Wednesday afternoon, Bank of America Merrill Lynch said “now the ball is back in the government’s court”.
“If it buys, the market stabilises (temporarily); if it doesn’t, the market tanks,” the bank said. “After all, the market at this level is still very expensive and fundamentals are rapidly deteriorating.”
Mainland China’s “national team” was seen back in the battlefield on Wednesday afternoon, when it propped up the benchmark index up, which recovered most of the 4 per cent loss in the morning session, by placing big orders for heavily weighted PetroChina and Sinopec.
Share prices of the two companies gained more than 3 per cent in intraday trading, and closed higher against the backdrop of plunging oil prices.
Xie Jun, director of GF Securities’ wealth management department, said it was unlikely an avalanche would take place, with forced liquidations triggering one another.
“As you can see, the national team is still with us,” he said. “They have their tolerance range, although they will not intervene in the market with the same force as last year.”
Another potential risk, according to analysts, is the withdrawal of capital from the stock market by financial institutions to meet requirements from regulators and investors.
Last week, Agricultural Bank of China, one of China’s four biggest state-owned commercial banks, announced it might have lost 3.9 billion yuan (HK$4.6 billion) after wo staff allegedly sold bills illegally and invested a large sum of the money in the stock market.
Analysts fear other illegal or unregulated capital flowed into the stock market during last year’s bull run and got trapped when the stock market crashed in mid June. These banks and institutions are pulling out the capital after the Agricultural Bank scandal.
“Don’t forget the more than 20 trillion yuan worth of wealth management products,” Xie said. “Retail investors tend to redeem these products when the stock market falls.”
Meanwhile, many private hedge funds were being forced to clear their positions as the index fell close to the 2,700 level, sources said.
“Many hedge funds set up during the first half of 2015 to catch up with the bull run have seen the market correct by 40 per cent since then, and some are forced to leave the market at this stage,” Wu said.