World Economy

Record Surge in Margin Debt Fuels China Stock Rally

Record Surge in Margin Debt Fuels China Stock Rally
Record Surge in Margin Debt Fuels China Stock Rally

Stock forecasters in search of an early-warning system for the next Chinese bear market are zeroing in on the country’s record $358 billion pile of margin debt.

When that three-year build-up of leveraged positions starts to unwind, regulators will struggle to limit the selloff, according to Bocom International Holdings Co. and Rabobank International, Bloomberg reported.

Almost all of this year’s biggest declines in the Shanghai Composite Index, including a 6.5 percent slump on May 28, were sparked by investor concerns over margin-trading restrictions. The securities regulator announced plans Friday to limit the amount brokerages can lend for stock trading.

“There’s definitely a ceiling on margin-lending,” said Wu Kan, a Shanghai-based fund manager at Dragon Life Insurance Co., which oversees about $3.3 billion. “Once leveraged investors begin to cut their holdings, it means they’ve turned cautious on the market and that will probably spark a correction.”

A pullback by margin traders would undercut one of the biggest drivers of the rally that’s lifted the value of shares to more than $10 trillion for the first time. With so much borrowed money at stake, market downturns run the risk of snowballing as traders are forced to sell shares to meet margin calls, said Anthony Neoh, a visiting professor at the National University of Singapore and member of the Chinese securities regulator’s international advisory body.

  Previous Routs

The Shanghai Composite tumbled on May 28 after a brokerage increased its margin requirements, or the collateral put up by investors when borrowing to buy shares. The gauge plunged 7.7 percent on Jan. 19 after a regulatory suspension on new margin accounts at some of the nation’s biggest securities firms. On both occasions, the index recovered within days as margin loans kept climbing.

The benchmark stock measure slumped 1.7 percent from its highest level in more than seven years at 11:09 a.m. local time.

Hao Hong, the chief China strategist at Bocom International, says policy makers face a choice: enact margin curbs and bring an end to the bull market, or let leverage keep growing and risk an even bigger market crash down the line. They also have to contend with loans that make their way into the stock market through China’s shadow finance sector.

“The regulator is trying to slow down the growth without triggering panic,” Hao said from Hong Kong on June 11. “If margin loan growth starts to decelerate notably, the market will slow down. If non-compliant margin lending accounts must be closed, the market will crash.”

Meanwhile, the China Securities Regulatory Commission is planning to curb the amount of margin finance and short selling to no more than four times a brokerage’s net capital, according to draft rules posted on its website June 12. There is currently no ceiling.