Commercial and residential buildings stand illuminated at night in Hong Kong, China, on Thursday, July 21, 2016. Hong Kong's trade balance figures are scheduled to be released on July 26. Photographer: SeongJoon Cho/Bloomberg
Hong Kong’s Hang Seng index is trading at close to a nine-month high © Bloomberg

Hong Kong’s securities watchdog is aiming to crack down on margin finance following a number of high-profile collapses in the share prices of traded companies.

The Securities and Futures Commission on Thursday recommended guidelines that would bar brokers from offering margin loans for stock purchases of more than five times clients’ capital. The new rules are set to take effect on October 4.

Margin financing, whereby brokers take traded shares as collateral for loans, has become a thriving business in recent years. In Asia, tycoons searching for access to liquidity have routinely pledged high percentages of the shares in their companies.

But the activity has attracted scrutiny from regulators that point out the risks to ordinary shareholders and the potential for steep drops in company share prices.

If a pledged stock falls below a certain level, that can result in a “margin call” whereby the borrower must either put down more shares, pay back the loan or forfeit some of the stock. If the broker decides to sell off some of the stock, the company’s share price can plummet. Such incidents can wipe billions of dollars in market value in just hours.

“Managing margin lending risk is crucial to ensure brokers’ financial stability and protect market integrity,” said Ashley Alder, chief executive of the SFC. “The new guidelines will ensure a level playing field and consistent risk management practices.”

The combination of a high level of leverage in the system and a number of recent share price collapses in Hong Kong has put pressure on the SFC to introduce rules.

Margin loans from brokers hit HK$206bn ($26bn) at the end of 2017, growing nine times since 2006, according to data from the SFC.

In January, shares in Jiayuan International, a Chinese property developer, plunged more than 80 per cent, raising questions over how much of the company’s stock had been pledged. Shares in China Huishan Dairy tumbled more than 90 per cent in 2017, clearing $4.1bn from its market value. It was later revealed that more than 70 per cent of the company’s shares had been pledged for loans.

Hong Kong’s Hang Seng index was down slightly on Thursday at 29,936 but is trading at close to a nine-month high. The benchmark hit an all-time high of more than 33,000 last year.

“The market is already at a very high level near 30,000 points so the SFC wants to keep stocks in a safe position,” said Francis Kwok, managing director at local brokerage Freeman Securities. “The new rules will have some impact on small-caps because some of them have taken on lots of leverage.”

Companies with small market capitalisations have been a target for market manipulation in Hong Kong. In 2017, a network of small-cap stocks fell in unison, erasing $6bn in value. Ownership of those stocks have been shown to be highly connected.

Under the SFC’s proposed rules, brokers would be instructed to control risks from significant exposure to margin clients and from holding individual or connected securities as collateral.

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