Explainer: Margin finance in China

The frenzied rise of the Shanghai stock market in recent months has been fuelled by a rise in margin lending. This is how it works.

What is margin financing?

It is using borrowed money to buy securities, rather like taking out a mortgage to buy a property. The investor borrows money from a broker, with the loan being secured against the assets purchased. He also has to put down a deposit, or margin, which is initially equal to the cash he is putting into the transaction. If losses go above this amount, the investor has to deliver more cash (or other assets) to the broker as security or the position is closed. Trading on margin magnifies gains and losses and regulators often limit the amount investors can borrow.

When did margin financing in China begin?

Before 2010, margin financing was not officially authorised in mainland Chinese stock markets, although it occurred informally on a small scale. The China Securities Regulatory Commission launched a pilot programme for margin financing in March 2010. It became a standard programme in October 2011.

What kind of investors are allowed to trade on margin?

In the initial stage of the programme, investors were required to have had an open account at a registered securities company for at least 18 months, with the value of cash and stock in the account at least Rmb500,000.

But in 2013 the CSRC lowered the account-opening requirement to six months and said it was cancelling "window guidance" on the minimum value of account holdings. Brokers interpreted this change to mean they were now permitted to set their own requirements. Actual limits ranged from Rmb2m to zero. On Friday the CSRC reiterated the minimum Rmb500,000 threshold.

The initial margin requirement is 50 per cent of the margin portfolio in the form of cash or securities.

Are rules for margin financing different in China than other markets?

Not really. The main difference is the type of investors involved. The Shanghai and Shenzhen markets are dominated by retail investors prone to speculation. That creates more risks compared to markets where institutional investors are the main participants.

Is margin financing more widespread in China than elsewhere?

No. Margin loans outstanding for the Shanghai Stock Exchange totalled Rmb767bn on January 16, equal to about 3 per cent of market capitalisation, according to Financial Times calculations based on stock exchange data. That's similar to the ratio for the New York Stock Exchange.

Though the absolute level of margin financing remains reasonable, regulators are also concerned at the speed of the increase. Margin loans outstanding have nearly tripled since June.

Why did CSRC punish Chinese securities companies?

The agency punished 12 companies in total, based on two-week on-site inspections of 45 securities companies conducted in December. It found repeated violations at Citic Securities, Haitong Securities, and Guotai Junan Securities, including improperly rolling over margin contracts.

CSRC rules say the term of a margin loan must not exceed six months. This rule is intended to force investors to close out their trades after six months and recognise any losses, rather than using credit to keep trades open indefinitely.

Nine other brokerages were also cited, mostly for serving unqualified clients. They will be subject to further inspections.

Will the crackdown on margin trading kill China's stock rally?

It's not clear yet. Bearish analysts have been saying for weeks that the huge run-up in share prices has been driven mainly by speculation and margin finance. Bulls counter that falling interest rates and a weak real estate market have made stocks look more attractive compared to other asset classes. They also point out that valuations in China remain reasonable compared to other markets.

Additional reporting by Ma Nan

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