Everyone in the world of capital markets loves a good first-of-a-kind trade. But Guotai Junan’s recent Rmb500m ($78.3m) margin loan ABS had many scratching their heads. Was it good or bad for the market?
The good option is the easier one to tackle. As the first Chinese ABS to use margin loans as collateral, Guotai Junan opens up a new funding avenue for the securities industry. That helping hand hasn't come a moment too soon given that firms have seen their revenues take a drastic hit due to the recent suspension of new listings as well as secondary trading for a multitude of stocks.
But market observers are also worried that allowing Chinese brokers to securitize margin loans could potentially snowball into a systemic crisis.
Margin financing volumes have increased exponentially this year, with the Shanghai Stock Exchange showing a record Rmb1.48tr of outstanding margin debt on June 19, a year-on-year increase of 560%.
If the securities firms start freeing up their balance sheets through margin loan ABS, only to continue their lending to what many fear are already overleveraged investors, the concern is that things could soon escalate out of control.
But that is not how China works. If the situation is left unchecked things could very well go awry. But comparisons with the struggle that authorities have had in keeping the equity market under control in the recent turmoil don't really apply here.
First, this asset class is only just beginning, and is being closely watched. The China Securities Regulatory Commission (CSRC) has made it clear on multiple occasions that it intends to rein in margin financing. In June it capped the total amount of margin lending brokers could engage in at four times net capital, while reiterating its ban on illicit margin lending through mechanisms such as umbrella trusts.
As of August 14, the outstanding balance of margin loans on the Shanghai Stock Exchange was down 40% from its peak in early June, to around Rmb886bn. Obviously some of that can be attributed to unwinding of loans, but local lawyers argue that a more important factor was the signal sent by the imposition of the cap.
Second, margin loan ABS ought to be much easier to control than the stock market, which is huge and retail-heavy. Margin loan ABS originators are brokers, who are under the direct supervision of the CSRC, and the main buyers are banks, who are regulated by the China Banking Regulatory Commission (CBRC).
Plus, the asset class still has a long way to go before it outgrows the regulator’s control. It took China more than two decades to develop its stock markets and we’re only two weeks into margin loan ABS. To put things into perspective, the Rmb500m freed up by Guotai Junan is just 0.05% of the outstanding amount of margin debt on the Shanghai Stock Exchange. Citic Securities has also announced plans for up to Rmb1.5bn of margin loan ABS, but the two are still nowhere near enough to move the needle.
And if the Guotai Junan deal is anything to go by, the Chinese are treading very carefully, setting high hurdles for the asset pool to ensure that only the strongest assets will be included.
It’s going to take many more rounds of securitization before the brokers run out of high quality assets to securitize and even then a crisis only has a chance of happening if the proceeds are indeed recycled to provide further margin lending.
But that seems highly improbable given that the brokers risk the wrath of the CSRC if they attempt to do that. It’s bad enough to go against the wishes of any regulator, but this is especially true when it comes to a highly regulated market such as China.
It’s not that critics are mistaken in saying that margin loan ABS has the potential to go wrong. The same could be said of anything when taken to excess. But Chinese regulators are not likely to change their measured approach to the asset class anytime soon. When it comes to margin loan ABS, that is no bad thing.