This Is Why So Many Chinese Companies Are Suspended

China's corporations have been big fans of stock-based loans, too

China's Market Meltdown in 75 Seconds

At least 1,331 companies have halted trading on China's mainland exchanges, freezing $2.6 trillion of shares, or about 40 percent of the country’s market value, Bloomberg reported on Wednesday.

The Shanghai Composite Index fell 5.9 percent on Wednesday. It's now about 32 percent below the peak of 5,166 it reached on June 12. The unwinding of margin loans is adding fuel to the fire. Individual investors in China, as we all know by now, have used generous margin financing terms to enter the stock market and then build up their portfolios. Less-known is that Chinese companies have been doing the same thing by using their own corporate stock to secure loans from banks.

This means that they stand to lose a lot when those share prices start trending dramatically lower. 

Says Nick Lawson at Deutsche Bank: "Stocks are being suspended by the companies themselves because many have bank loans backed by shares which the banks themselves may want to liquidate, joining the queues of margin sellers."

Nomura analysts added that: "Some bank loans have been extended with shares of listed companies put up as collateral."

Numbers here are sketchy, but the team at Nomura estimated that the total amount of such loans may be 500 billion yuan to 600 billion yuan ($80 billion to $96 billion). This sounds like a lot but is equivalent to about 1 percent of total loans to Chinese enterprises.

Still, the dynamic at play is reminiscent of the troubles encountered by U.S. energy companies, thanks to the plunging price of oil. Many shale explorers have bank loans tied to the value of their oil and gas reserves. When the price of oil began sinking last year, those credit lines were generally reassessed at a lower value, limiting the amount of credit available to the energy companies and putting further pressure on companies that were already dealing with the fallout from dramatically lower crude prices.

The easiest way to stop a painful cycle by which lower share prices lead to curbed corporate credit, further troubles for Chinese companies, and ever-increasing share price pressures is to halt stock trading altogether.

Speaking of which, the latest move from Chinese regulators announced on Wednesday bans corporate executives from selling stock for six months.

This vicious circle described above also explains why China's central bank has quickly moved to support the market in an effort to limit its effects on the wider economy. 

Source: Bloomberg
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