China Wants to End Bubbles and Busts by Targeting Margin Loans

  • Drop by U.S.-traded Chinese shares shows move was unexpected
  • Officials seen learning from mistakes of boom-bust this year

No more bubbles. That’s the takeaway from China’s move to limit leveraged bets in its equity market.

The country’s two mainland stock exchanges said late Friday margin requirements will be raised to 100 percent from 50 percent starting on Nov. 23. The rule change means that investors with 1 million yuan ($156,895) in their accounts are limited to borrowing another 1 million yuan from a broker to buy more shares. Previously, they could borrow as much as 2 million yuan.

While U.S.-listed Chinese companies and exchange-traded funds tracking mainland shares slumped on concern the curbs will hurt investor confidence in the world’s second-largest stock market, Hermes Investment Management Ltd. and Union Bancaire Privee say limiting speculative activity now will provide a stronger foundation for the nation’s equities to extend a bull-market rebound.

“This is a very responsible step on the part of the authorities to nip the growing bubble in the bud,” said Gary Greenberg, who helps oversee about $1.8 billion as head of emerging-market equities at Hermes Investment Management in London. “In the very short term it might have a negative effect, but long term it increases the robustness of the Chinese market.”

The Shanghai bourse said the restrictions will help prevent systemic risks from building in China’s financial system. Margin financing, which shrank by more than half during the rout, rose for the past six weeks as the Shanghai Composite Index rallied more than 20 percent from its August low. The equity gauge rose 0.7 percent at the close amid speculation state funds intervened.

Surging margin debt helped amplify the record-breaking boom -- and subsequent bust -- in Chinese stocks earlier this year as easy access to leverage gave the country’s millions of individual investors increased buying power.

A Bloomberg index of American depositary receipts on Chinese stocks declined 4.2 percent in New York on Friday, the most since Aug. 24. The Deutsche X-trackers Harvest CSI 300 China A-Shares ETF, the biggest U.S. exchange-traded fund investing in mainland shares, lost 3.3 percent.

Even so, the options market shows foreign investors are growing less pessimistic over the longer term, with the cost of buying bearish contracts on the Deutsche X-trackers ETF falling to the lowest level since June relative to bullish ones.

"The Chinese acted preemptively to stop the rally from being uncontrolled,” Koon Chow, senior macro and currency strategist at Union Bancaire Privee in London, said by e-mail on Friday. “I think the move happened at a very good time -- before speculative and margin-fueled trading drove the equity market higher again."

Summer Debacle

Margin debt and volume rose “rapidly” in recent weeks as some investors bought shares trading at high valuations, the Shanghai exchange said in a post on its Weibo account explaining the rule change. The move will help reduce leverage and ensure “healthy development” of the market, it said.

"We doubt this will in itself derail the recovery in equity prices, particularly since it only affects new purchases," said Michael Shaoul, chairman at Marketfield Asset Management LLC in New York. "Perhaps the most important takeaway is that the authorities were embarrassed by the summer debacle and will not be shy to intervene if they believe there is any danger of a repeat.”

The Shanghai Composite tumbled 43 percent from its June 12 high through Aug. 26 as investors cut leveraged bets by more than $200 billion. The rout was only halted after the government took unprecedented steps to prop up share prices, including banning major shareholders from offloading shares, ordering state funds to buy stocks and restricting short selling.

Confusing Signal

Uncertainty over the direction of intervention in the equity market will increase volatility, according to Ankur Patel, chief investment officer at R-Squared Macro Management LLC.

The Shanghai Composite fell 0.3 percent last week after regulators lifted a freeze on initial public offerings, removing one of the key measures of support for stocks. While a gauge of 60-day price swings on the equity gauge has dropped from an 18-year high in September, volatility is still the most extreme among global benchmark indexes tracked by Bloomberg.

"It really is a confusing sign if you consider that the Chinese for months had tried to stabilize equity markets," Patel said from Birmingham, Alabama. "The two-way risk means the Chinese markets and Chinese investors in general are unlikely to kind of pile in to assets wholeheartedly, it’s going to be more of a two-way flow."

For John Manley, who helps oversee about $233 billion as chief equity strategist for Wells Fargo Funds Management in New York, the move reflects a desire by officials to increase the influence of China’s financial markets. The yuan is poised to be accepted by the International Monetary Fund as a top-rank reserve currency, while MSCI Inc. is considering adding mainland equities to its global benchmark indexes.

“China is trying to find its place as a legitimate power in the world,” Manley said. “And that requires they take on certain restrictions and regulations and that they do certain things to become part of certain favored currencies, and they move up in the world. And I think that’s what they’re about, and I think that’s a very good thing to be doing.”

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