Who’d be an equity investor? The Shanghai Stock Exchange Composite Index dropped by 7.7% on Monday, January 19, while the Hong Kong Hang Seng Index ended the day 1.5% lower. Yet while these losses were big, it was the shares of brokerages that were completely pummelled this week.
Hong Kong-listed Guotai Junan International Holdings lost around 9.5%, while Citic Securities and Haitong Securities — two of China’s largest listed brokerages — hit the 10% daily limit on Monday and then fell more later.
Of course, the damage to their stocks was not without reason. On Friday, the Chinese regulator banned these firms from opening new margin trading accounts for three months, while also penalising nine other brokerages. The list of violations they have been accused of includes illegally rolling over contracts and allowing investors that were not qualified to open margin finance and securities lending accounts.
The CSRC’s motivation is clear. The country’s stock market had an extremely bullish 2014, with the Shanghai Index posting one year returns of around 65%. In comparison, the Hang Seng has returned just 8.29%.
But hand-in-hand with the bullishness of the Chinese market has come a spike in margin trading — a way by which investors purchase stock using a combination of their own money and borrowings from brokers. Margin loan balance rose nearly 50% between November and December alone last year, with the lending standing at a whopping Rmb1tr ($160.82bn) at the end of 2014.
The figure is large enough to spook any regulator, so it’s no surprise that the CSRC decided to bring the party to an abrupt end. The ramifications of ending up with a heavily leveraged financial system are far-reaching, as many countries and banks found out during the 2008/2009 financial crisis. China’s move to curb excess leverage and speculation by nipping it in the bud now ensures it will avoid those exact pitfalls.
Not just that, but it is also being prudent about how far it goes in controlling the brokerages’ margin lending. It has banned just three securities firms — and only for three months — rather than implementing a system-wide ban on margin financing. This has helped send a strong signal to others in the industry to clean up their act quickly or face the consequences.
Good timing
The CSRC’s timing is spot-on. Most Chinese companies are in a blackout period at the moment as they update their financial statements. And with Chinese New Year looming in mid-February, any equity raising from issuers was expected to be minimal, considering the small window of opportunity available to execute deals at the moment.
By increasing scrutiny on brokers now, the CSRC is allowing for short-term volatility, knowing full well that it should calm down by the time both the Chinese and Hong Kong markets get back into full swing following the CNY break.
Sure, the securities firms will lose some of their clients during the ban and will have to rejig the way they operate in the future. But that looks to be the only price they have to pay for stronger capital markets. At this stage, market watchers reckon their planned equity fundraisings — such as Citic and Haitong’s chunky private placements, as well as IPOs by other Chinese financial institutions — will remain unscathed.
Taking tough measures and having stocks tumble over one day is unfortunate. But if the reward is having a stable and more transparent market for the rest of the year, then the CSRC has taken the right approach. Hopefully it’s one that will reap benefits for years to come.