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

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.

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.”