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SHCOMP Slumped; Bear Market Now?
By: Louis Wong
Articles (12) Profile

The Chinese stock market continued to slide. The Shanghai Composite Index slumped 3.3 percent to close at 4053 this Monday, extending the loss from its peak of 5178 seen on June 12.  A surprise interest rate and reserve-requirement ratio cut by the People’s Bank of China (PBOC) over the weekend failed to lift the market.

The index is now 21.7 percent lower than the peak on June 12, crossing a 20 percent threshold that defines a bear market.  Investors may have a lot of questions to ask, for instance: What caused the drastic sell-off? Will further easing by the PBOC help stop the slide?

CSRC’s Approved IPOs Possible Cause

It is believed that a wave of new initial public offerings (IPOs) is one of the reasons behind the latest wave of selling. Up to June 10 this year, 192 companies have raised RMB 255 billion, more than five times the RMB25.5 billion raised in the same period of last year.

As the Chinese Securities Regulatory Committee (CSRC)  had approved another 28 IPOs last week, subscriptions for these upcoming IPOs may tie up more than RMB 4 trillion in early July.

Additionally, the CSRC is cracking down on unregulated margin lending or the so-called shadow lending to stock investors. China officially launched margin trading by securities brokerages as a pilot project in 2010.  Brokerages can only offer margin financing to investors with cash and stock worth RMB 500,000.

Unregulated Margin Lending

Leverage is capped at 1:2, which represents RMB 2 in loans for every RMB 1 of the investor’s own funds. Additionally, only certain stocks are eligible for margin trading. However, few rules apply in the grey market of unregulated margin lending.

Leverage can reach 5:1 or higher, and there are no limits on which shares investors can trade. The money for these unregulated margin lending comes mainly from wealth management products sold by banks and trust companies.

This guarantees a fixed return and from so called “fund-matching” companies known in Chinese as Peizi. These fund-matching companies will open securities accounts with brokerages, then divide the accounts into multiple sub-accounts that enable their Peizi clients to trade independently.

Being the official account holder, the fund-matching companies maintain ultimate control and can liquidate any sub-account if the investor suffers heavy losses.

There is no reliable data on this kind of shadow lending but it is estimated that between RMB 500 billion and RMB 1 trillion in margin lending from trust companies has flowed into the stock market.

The CSRC ordered brokerages to stop working with umbrella trusts in mid-April and followed up with rules announced on June 13 that forbade brokerages to co-operate with fund-matching companies.

PBOC Failed To Lift Market

China’s stock market began its slide on June 15.  Official margin lending also started to decline after totaling RMB 2.27 trillion on June 18.  Up to June 25, margin debt outstanding has dropped 3.96 percent to RMB 2.18 trillion but it still shows a fivefold increase from a year ago.

If the market falls further, it could lead to more forced selling to unwind margin trading.  That may explain why the PBOC’s move to cut interest rate and banks’ reserve requirement ratio failed to lift the market.

After four interest rate cuts in seven months, the PBOC is unlikely to cut its benchmark interest rate further this year.  So the latest cut may actually be seen in a negative light by the market.

Louis is one of the most experienced fund managers in Hong Kong and has more than 25 years of solid experience in the financial markets. He employs a strict criteria for choosing his stocks, which is deeply insistent on having a thoughtful and sophisticated analysis of the company before making any investment decision.

Please click here for more information about this author.

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