China walks US$264 billion tightrope as margin debt powers stocks

[BEIJING] Confident that China's stock market rally still has legs, Jiang Lin recently began borrowing money from her brokerage to buy more shares.

Her newly-opened margin finance account with state-owned China Investment Securities has allowed Jiang, a 29-year-old marketing executive in Beijing, to double up her bets on the vertigo-inducing rally in Chinese share prices.

"It's worth the risk," said MS Jiang, while admitting she doesn't fully understand how margin finance works because she hasn't had her broker explain it to her.

Investors such as Jiang are part of a US$264 billion dilemma facing the country's securities regulator, the China Securities Regulatory Commission, after the Shanghai Composite Index climbed on Monday to a seven-year high. Should it tighten its rules governing margin finance and risk triggering a crash, or continue tinkering with regulations and see stock purchases on credit rise to potentially perilous levels?

Traders are betting that the regulator will shy away from any serious steps to curb an explosion of margin finance, which fueled a 93 per cent one-year surge in Shanghai's benchmark gauge. Securities firms' outstanding loans to investors for stock purchases were a record 1.64 trillion yuan (S$362 billion) as of April 10, up 50 per cent in less than three months, despite bans imposed by the CSRC in January and April on lending to new clients by four Chinese brokerages.

China's margin finance now stands at about double the amount outstanding on the New York Stock Exchange, after adjusting for the relative size of the two markets.

"Regulators are aware of the risk of rising margin debt but they can't afford to puncture the equities bubble with very draconian measures," said Lu Wenjie, a Shanghai-based analyst at UBS Securities. "They want to pelt the mice without smashing the china."

With growth faltering and real estate prices heading lower, China is wary of adding a stock market crash to its economic problems, according to Mole Hau, a Hong Kong-based economist with BNP Paribas.

There's also a political dimension because equity markets are dominated by small retail investors, some of whom may face ruin if a market slump prompts brokers to call in loans. Individual investors make up about 90 per cent of equity trading in China, according to the CSRC.

The stock market's upward march was delayed by only a few weeks in January by the CSRC's three-month bans on Citic Securities, Haitong Securities and Guotai Junan Securities for letting customers delay repaying financing. This month's news that another six brokerages faced penalties for their margin lending was also brushed aside by investors.

Sterner measures could include tightening capital requirements for brokerages and raising the asset threshold for investors seeking margin finance, said Castor Pang, Core Pacific-Yamaichi Hong Kong's head of research. For now, clients must have at least 500,000 yuan of assets.

The CSRC indicated it could be considering tougher action when its chairman Xiao Gang was quoted by China National Radio last month as saying it's planning revisions to regulations on margin finance and securities lending to prevent systemic risk. Mr Xiao didn't give details of the possible measures.

Regulatory interventions such as stamp duty hikes and curbs on day-trading mechanisms have triggered three market slumps since the 1990s, according to UBS's Mr Lu.

The authorities may also be tempted to hold off because stock valuations remain lower than levels before past market collapses. The Shanghai Composite is at about 20 times reported earnings, or less than half of the level it reached during a 2007 rally.

In the absence of tougher measures, the regulator is likely to continue brokerage inspections and impose temporary bans or fines for specific infractions, said Core Pacific-Yamaichi's Mr Pang. The CSRC this month added Great Wall Securities to the suspension list while warning another five brokerages including Huatai Securities for violations of margin finance rules.

The bans on Citic, the nation's biggest brokerage, Haitong and Guotai Junan expire on Thursday, leaving the firms free to seek new clients again. They have the capacity to do so, said Zheng Chunming, a Shanghai-based analyst at Capital Securities. He calculates that Chinese brokerages can boost margin loans to as much as 2 trillion yuan if they raise their capital and leverage ratios to regulatory ceilings.

"The return of three large brokerages will definitely add to the rapid growth in margin debt," said Mr Zheng. "A lot has to do with market sentiment, which is irrational at the moment."

BLOOMBERG