Broker beware insidious margin trading curbs

Chinese regulators have punished brokers and tightened rules on margin trading. This shouldn't hurt them in the short term but longer term might be different.

Not so much buyer beware as broker beware.

The Shanghai stock market suffered its worst day for six years on Monday after Chinese regulators tightened rules on margin trading.

On Friday the China Securities Regulatory Commission punished 12 mainland brokers over rule breaches on margin trading.

Before Friday, brokers were apparently hoping for a relaxation of rules regarding margin financing, including a reduction in the minimum assets held by would-be clients.

The reality, as is typical, came as something of a surprise: twelve brokers punished, with Citic Securities, Haitong Securities and Guotai Junan Securities barred from taking on new clients for three months.

Rules were subsequently tightened, including the re-affirmation of minimum asset levels of Rmb500,000 rather than the Rmb100,000 used in reality.

“[The] CSRC’s announcement sends a clear signal that regulators may want to cool down the recent fever in the stock market,” Chen Long, chief analyst at Dongguan Bank in Guangdong, told FinanceAsia.

The Shanghai Composite index rose about 50% in 2014 and there is a clear desire for that to not overheat and reverse course.

On the face of it this is not good news for the country’s brokers, some of which are in the process of tapping capital markets for funds.

Margin financing, in which investors borrow money from brokers to buy stocks, increased by 191% between January 1, 2014 and December 19, according to JP Morgan research.

The margin financing and stock lending business is already the third-largest revenue source for brokers (around 20%), behind the brokerage and proprietary trading businesses.

Citic Securities and Haitong Securities in January kicked off an expected busy few quarters for share placements and initial public offerings by brokers; with the former seeking $3.9 billion and the latter $4.5 billion.

Guangzhou-based Guangfa Securities and Nanjing-based Huatai Securities are each eyeing a $1 billion Hong Kong listing in the first half of 2015, while Guolian Securities is also looking at a $300 million H-share listing by year-end.

Haitong Securities on Monday told investors on a call that its punishment would reduce revenue by Rmb9 million over the three-month period it is unable to pickup new clients, while a Beijing-based analyst told FinanceAsia the three banks hit with suspensions could lose 2% of revenue during the period.

Meanwhile, Credit Suisse on Monday downgraded Citic Securities' and Haitong Securities' earnings by 4%-5% given the lower assumptions on their margin finance businesses.

The action by the CSRC is not exactly draconian and more a slap on the wrist. It is a show of strength to the industry to get its house in order or pay the price.

Haitong Securities, for example, said on the investor call that the punishment would have little impact on its capital needs and it would not revise its share placement plan.

“The punishment itself will not effect brokers’ fundraising activities,” a Beijing-based banker working on such a plan told FinanceAsia. This is a view shared by Credit Suisse.


That said, if Monday’s 7.7% drop for the Shanghai index – its biggest since June 2008 – is anything to go by, there could be a more insidious element for investors and, indirectly, for brokers looking to raise funds in the capital markets.

Two thirds of China’s margin financing capital comes from the bank system rather than brokers, according to Chen Long, chief analyst at Dongguan Bank in Guangdong.

“We are worried whether the China Banking Regulatory Commission and the People’s Bank of China will follow and step in to prevent banking capital from flowing into the stock market,” Chen told FinanceAsia.

Should the other two Chinese regulators step in, a dampening effect on the Shanghai and Shenzhen stock markets could easily turn into a rout.

One Beijing-based banker working on a fundraising for a domestic broker told FinanceAsia that, if share prices continued to fall, he was afraid investors might turn a cold shoulder to brokers’ deals.

Furthermore, Credit Suisse in its research note said the three brokers could lose some clients to rivals during the three-month ban. Brokers may also act more cautiously in future and not sail so close to the wind.

This could of course dent the brokers’ revenues and trigger a common correction in their valuation.

But perhaps this is part of the point: making an example of a few for a greater good.

“In the longer run, we think better leverage control could help curb excessive volatility in the A-share market,” Goldman Sachs said in a research report.

In short, the possibility of scuppering a few mainland brokers’ fundraising plans or denting their revenues is a small price to pay for keeping markets calm.

The action is but one piece of a jigsaw that China is only part way through, with more reform clearly on the way, including to the IPO market, Exchange-Traded Funds and individual stock options.

Along the way there will be casualties of various sizes but on the whole this latest move should be absorbed by brokers without too much fuss.

But if keeping the markets calm is the plan for China’s regulators, they will not want many more days like Monday.

Additional reporting by Jing Song

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