Michael Yang

1017800664@qq.com

CHINA’S stock market has roared back, with the Shanghai Composite Index making a 25 percent rally in the last three months. The surging market has spawned huge demand for margin lending, and firms that offer grey margin finance are coming alive again.

In China, margin financing are divided into two types: official financing, which is offered by brokerages, overseen by securities regulators and in which the shares that investors can buy with leveraged loans are limited to just a few hundred firms, and undercover margin lending, which offers much higher leverage ratios and lenders do not dictate what stocks investors can buy.

The revival of grey margin finance comes along with a rebound in regulated margin loans, which at the start of February was at its lowest level since 2014. Official figures show that outstanding loans in the official margin financing market had jumped to 902.22 billion yuan (US$134.50 billion) as of Wednesday last week, up nearly 30 percent since the end of January.

Meanwhile, unofficial margin financing, in which small investors borrow from grey market lenders, is thriving, with shadow bankers happy to offer quick funding to investors who are eager to pile into the stock market to capitalize on the market rally.

According to media reports, leverage ratios offered by some shadow margin financing firms are as high as 10-to-1, compared with 1-to-1 for regulated channels provided by brokerages.

Higher leverage means investors can earn more when stocks rise, but they will suffer steeper losses when their stocks fall. At a 10:1 ratio, a stock price decline of about 10 percent would wipe out an investor’s entire investment. The surge in shadow margin financing helped the Shanghai stock index double between 2014 and mid-2015, forcing the authorities to crack down on such business and causing a 40 percent decline in stocks over six months.

Still fresh from memories of the 2015 crash, regulators have been increasing scrutiny of the quick increase of leveraged buying funded by shadow lending and have been warning against risks of another credit-fueled bubble.

Subsidiaries of the China Securities Regulatory Commission (CSRC) in Zhejiang and Guangdong provinces held meetings recently with local brokerages, flagging potential risks associated with illegal margin financing and banning them from doing any form of business that could facilitate such a business. CSRC officials also urged the industry to learn the hard lesson from the 2015 crash.

In its latest move to take aim at the gray market margin financing, the CSRC last week handed down penalties to Western Securities Co. and Capital Securities Co., asking for the removal of two branch chiefs of the brokerages as they cooperated with illegal funding platforms to lend money to investors for stock trading.

After decades of relying on bank loans, China now wants to lift the weight of equity financing in its total social financing and wants the nation’s stock and bond markets to play a bigger role in funding its economy. A strong capital market can certainly serve the goal.

All the pre-emptive measures taken by regulators to ward off any potential risks are necessary as a rampant growth in leveraged stock buying financed by unregulated margin lending will certainly result in a mad bull market and a repeat of the 2015 stock rout. To nip any risk in the bud and put leveraged stock trading in check, China may have a restrained bull market to help its companies boost their direct financing via the capital market.