China stocks hit by margin lending curbs

Shanghai’s stock market suffered its worst fall in more than six years on Monday with China’s biggest securities brokerages hit by a crackdown on margin lending, an engine of the frenzied rise in mainland shares in recent months.

The China Securities Regulatory Commission said on Friday it had banned Citic Securities, Haitong Securities and Guotai Junan Securities, the largest brokerages by assets, from opening new margin trading accounts for three months, following investigations into high-risk margin trading.

The Shanghai Composite sank 7.7 per cent on Monday, its biggest loss since June 2008. The financials sub-index shed 9.6 per cent, with all 14 banking stocks down by their 10 per cent daily limit.

Brokerage shares have been among the biggest beneficiaries of a bull market that began in November and took the Shanghai Composite to its highest close in 65 months on Friday. Citic and Haitong have both taken advantage of surging share prices to raise fresh capital through private placements.

Margin financing, which allows investors to borrow money to buy into the stock market, has helped power the equities rally, with outstanding margin loans standing as of Friday at Rmb767bn ($123bn), according to Shanghai Stock Exchange data, from Rmb444bn at the end of October.

The CSRC’s move was “a nasty surprise”, wrote Hong Hao, strategist at Bank of Communications, in a note.

On Monday in Hong Kong, Citic and Haitong each sank 16.5 per cent while Guotai Junan fell 9.5 per cent.

Beyond the margin crackdown, China’s banking regulator also released draft rules on Friday to curb the growth of company-to-company loans, which have surged in recent years along with other forms of shadow banking.

Market participants say that funds from so-called entrusted loans — in which one non-financial company lends to another, with a bank serving as intermediaries — have flowed into the stock market. The new rules forbid the use of entrusted loans for equity investment, adding to investors’ sense that market liquidity is set to tighten.

Liu Jun, financials analyst at Changjiang Securities in Wuhan, said of the fall in the brokers’ shares: “We think this is an incremental adjustment. The fast growth potential for margin financing and other emerging business areas at the brokerages hasn’t changed, but it’s developed too quickly. The regulators see risks in certain areas.”

“The impact on these brokerages’ profits isn’t major. This is mainly a hit to sentiment,” Mr Liu added, noting that the three-month ban will cover the Chinese lunar new year holiday, which this year falls in late February, when markets are closed.

The CSRC said the three brokerages had wrongly rolled over some margin loans when they expired. Regulations require that when a financing contract expires, brokerages reassess the borrower’s risk profile before issuing a new loan.

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Citic has acknowledged it violated rules and on Monday told the Shanghai Exchange it “would no longer allow margin trading contracts to extend beyond the maximum six months”.

Before the clampdown, David Cui, strategist at Bank of America Merrill Lynch, warned in a report last month that the “fast and furious” rally in the Chinese stock market of late was “unsupported by fundamentals, and when the tide turns, we think the sell-off will likely be fast and furious as well”.

Investors have viewed brokerages in part as a momentum play on the broader market, as record turnover amid the market rise boosts income from commissions.

Even after its plunge on Monday, Citic’s mainland shares have still more than doubled since November, while Haitong’s are up more than 90 per cent.

Additional reporting by Patrick McGee and Josh Noble in Hong Kong