BEIJING – China’s stock market has been a hot topic since the summer, when a rapid rise gave way to a major plunge, triggering a global equities sell-off. The question now is what can be done to prevent further volatility.
To answer that question requires understanding how China got to this point. For years, with the authorities’ encouragement (or at least acquiescence), China’s securities companies spared no effort in pumping up China’s stock exchanges with fashionable financial instruments and practices, the sole aim being to realize capital gains from rising prices (dividends are rarely distributed). As a result, after years of poor performance, the Shanghai Composite Index soared by more than 100% in less than seven months, from 2,505 points in November 2014 to over 5,178 last June – a level that was not merited by China’s economic fundamentals.
The most important instrument driving this surge was margin trading, which enabled investors to borrow heavily to purchase shares. According to Bank of America strategist David Cui, some CN¥7.5 trillion ($1.2 trillion) in market positions are being carried on margin, “equivalent to some 13% of A-share’s market cap and 34% of its free float.”
Part of the problem was that margin trading was not limited to institutional investors. Lightly regulated “fund matching” companies, for example, would distribute margin loans to virtually anyone, resulting in about CN¥2.3 trillion in online private fund matching and CN¥1 trillion in offline private fund matching, with a leverage ratio of up to 5:1 for the latter.