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China’s Margin Debt Solution: Suspend The Shares

Earlier this week, the Wall Street Journal ran an article titled “Investors’ Zeal to Buy Stocks With Debt Leaves Markets Vulnerable,” which highlighted the fact that investors are borrowing a record $642.8 billion in margin debt, exposing them to billions in additional losses if bets don’t work out as expected.

But while margin debt in the United States is at an all-time record, in China borrowing against equities is off the charts.

Over the past 12 months, Chinese policymakers have been working to address the country’s mounting debts by tightening access to credit. However, some designers have refused to conform and instead are using their shares as collateral.

According to the Financial Times, a tightening of lending criteria has led to a “wave of share pledges by listed groups.” As of mid-December last year, an estimated 317 Shanghai and Shenzhen-listed companies had pledged at least 40% of their stock as collateral for credit.

This has enabled these companies and their founders to access funding outside the traditional banking sector, which has helped them circumvent tighter lending standards, but they’ve had to make compromises such as borrowing at higher rates of interest.

The issue with this type of lending is that the shares pledged can move in value, which means borrowers can be forced to sell shares to meet obligations if markets move against them.

It seems some managers are trying to avoid having to sell shares to meet margin calls by suspending trading in the shares, therefore suspending their value. It’s estimated that shares in around 10% of the companies listed on the Shanghai and Shenzhen exchanges are now suspended from trading.

Rather than clamp down on this practice, Chinese regulators are doubling-down. At the beginning of February,  the China Securities Regulatory Commission sent directives to mutual funds, brokerages, and major stockholders to limit selling and encourage buying, in an attempt to restore confidence.

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