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China’s stock markets face an overhang of 5.4 trillion yuan worth of stocks pledged as borrowing collaterals, which stand the risk of being sold off as the markets continue to fall and companies are forced to deleverage to cut risks. Photo: EPA

Sell-off in China’s pledged stocks may be double Hong Kong’s GDP

With the continual decline of Chinese equities, the 5.4 trillion yuan worth of stocks pledged as borrowing collaterals stand at risk of being sold off

China’s stock markets may be braced for a sell-off that is more than double the size of Hong Kong’s economy.

Already 5.4 trillion yuan (US$787.9 billion) worth of stocks have been pledged as borrowing collaterals by major shareholders in publicly traded companies, according to data compiled by Sinolink Securities.

The stocks now risk being liquidated as the decline in Chinese equities shows no signs of abating and companies and financial institutions are forced to deleverage to reduce risks.

Major shareholders of listed companies usually use their shares as collaterals to borrow money from brokerages, banks or trust firms. When the stock falls in the secondary market and reduces the value of the pledged shares, borrowers will have to take out more shares as collaterals. Otherwise, they will have to sell the shares to get back the principal.

The recent market shake-out has put investors on alert of the potential risks arising from the pledged stocks, given the sizeable amount involved.

Investors are bracing for a choppy ride as Beijing’s clampdown on speculative excess is dampening any bullishness in the markets. Photo: Bloomberg
Companies listed in China have had 14 per cent of their shares pledged as collaterals, accounting for about 11 per cent of the total market capitalisation of yuan-traded equities in Shanghai and Shenzhen, according to Sinolink. That outweighs Hong Kong’s gross economic output of HK$2.5 trillion (US$320.7 billion) in 2016.

“It’s just like a sword hanging overhead and the risk cannot be neglected,” said Wei Wei, a trader at Huaxi Securities. “It will put the market in a vicious cycle: the market decline will lead to dumping of pledged stocks, triggering more sell-offs by other investors. That’ll probably prolong the process for the market to seek the bottom.”

The Shanghai Composite Index has lost 5.4 per cent from this year’s high in April and the ChiNext has dropped 10 per cent so far this year. Photo: Xinhua
The benchmark Shanghai Composite Index has fallen 5.4 per cent from this year’s high on April 11 and the ChiNext gauge of small-caps is down 10 per cent so far this year as a liquidity squeeze dampens sentiment.

Pledged stocks valued at about 300 billion yuan have already fallen below their warning levels as of Tuesday last week, according to Minsheng Securities. A further decline would trigger margin calls to borrowers, who would be required to add more shares as pledges.

It’s just like a sword hanging overhead and the risk cannot be neglected
Wei Wei, Huaxi Securities

Companies that have recently listedare most active in pledging shares as they can borrow more based on market values, taking advantage of the stock rallies after the debut.

But the recent regulatory crackdown on manipulation of newly listed shares has landed companies, including First Capital Securities, in trouble.

As shares in the brokerage tumbled 67 per cent from their high in November, its third-biggest shareholder Nenking Group made five stock pledges this month to prevent money lenders from offloading the shares on the secondary market. Nenking has now pledged about 80 per cent of its stake in First Capital.

Though no forced liquidation has occurred so far, Sinolink warned investors against buying telecommunications, media and defence companies.

These sectors would be more exposed to risks linked to pledged stocks as shares in these industries had posted worse performances than others, the brokerage said.

This article appeared in the South China Morning Post print edition as: Shares pledged to borrow cash may be at danger levels
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