China Futures Tumble on Trust Curbs, Expansion of Short Selling

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Photographer: Qilai Shen/Bloomberg

Chinese stock-index futures tumbled after regulators clamped down on the use of shadow financing for equity purchases and increased the supply of shares available for short sellers.

FTSE China A50 Index futures for April delivery fell 6 percent as of 10:47 a.m. in New York, while contracts on the Hang Seng China Enterprises Index lost 3.3 percent. Regulators banned the margin-trading businesses of brokerages from using so-called umbrella trusts and allowed fund managers to lend shares to short sellers, statements on Friday showed.

Investors have used umbrella trusts, which allow for more leverage than brokerage financing, to ramp up wagers on Chinese stocks after monetary stimulus sparked a world-beating rally in the nation’s benchmark equity gauge. Permitting mutual funds to lend their holdings to short sellers would make it easier for bearish traders to bet on a retreat after the Shanghai Composite Index closed at a seven-year high on Friday.

“The surge recently has been a little too fast for the regulator’s comfort,” said Hao Hong, the chief China strategist at Bocom International Holdings Co. in Hong Kong. “The market should consolidate, as it is overbought and part of the market is overvalued.”

The Shanghai Composite, which more than doubled in the past 12 months, trades for 21.1 times reported earnings, the highest since April 2010 and more than double last year’s low, according

to data compiled by Bloomberg. The MSCI Emerging Markets Index is valued at 13.7 times.

Trust Investments

China’s trusts boosted their investments in equities by 28 percent to 552 billion yuan ($89.1 billion) in the fourth quarter. The higher leverage allowed by the products exposes individuals to larger losses in the event of stock-market drops, which can be exaggerated as investors scramble to repay debt during a selloff.

In umbrella trusts, private investors take up the junior tranche, while cash from trusts and banks’ wealth-management products form the senior tranches. The latter receive fixed returns while the former take the rest, so private investors are effectively borrowing from trusts and banks.

Margin debt on the Shanghai Stock Exchange climbed to a record 1.16 trillion yuan on Thursday. In a margin trade, investors use their own money for just a portion of their stock purchase, borrowing the rest. The loans are backed by the investors’ equity holdings, meaning that they may be compelled to sell when prices fall to repay their debt.

Short Sellers

Allowing funds to lend their stock holdings will expand the pool of equities available to short sellers, who have relied primarily on brokerages to supply them with the stock needed to execute the bearish bets.

While short selling on the Shanghai bourse climbed more than threefold in the past nine months and reached a record 7.46 billion yuan last week, the amount still pales in comparison to China’s $7.3 trillion market capitalization. The CSRC said Friday it also expanded the number of stocks available for short selling to 1,100.

Chinese investors have been piling into the equity market after the central bank cut interest rates twice since November and authorities from the China Securities Regulatory Commission to central bank Governor Zhou Xiaochuan endorsed the flow of funds into equities. China is trying to control credit expansion while protecting an economy that expanded 7.4 percent last year, the least in 24 years.

Mainland traders have opened a record 10.8 million new stock accounts this year, more than the total number for all of 2012 and 2013 combined, data from China Securities Depository and Clearing Co. show.

“The regulator is trying to reduce leverage,” said Lu Wenjie, a Shanghai-based analyst at UBS Group AG. “There could be a pull back in the market.”

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