Beijing Tries to Catch a Falling Knife

On July 8, multiple Chinese banks including the Bank of Communications and Bank of Ningbo announced they would offer favorable loans for share repurchase and stock rights acquisition of listed companies on orders of the China Banking Regulatory Commission. In addition, insurance companies, on orders of the China Insurance Regulatory Commission, bought RMB112.26 billion worth of shares through July 8.

Those are an indication of the extraordinary lengths China is going to in its attempt to turn around the long glissade in its stock markets, which have fallen further, faster, and with a bigger impact, than at any time in the country’s recent history. As much as US$3 trillion in value had disappeared before the bleeding slowed. The effort by Beijing, in magnitude if not practice, resembles the billions China poured into the economy starting in 2009 to seek to insulate it from the effects of the global financial crisis. That effort resulted in significant distortions in the economy that planners then had to work in turn to reverse.

Most observers regard the moves as a desperation attempt to undo the damage done by the artificial pumping of stocks since the first of 2015 as a method of reflating an economy that is unlikely to make its promised 7 percent gross domestic product growth. Starting in the third quarter of 2014, the government promoted the through-train sharing of stocks listed primarily in Shanghai and Hong Kong. It cut interest rates and reserve requirements, encouraged companies to bring IPOs to market and to attempt debt-for-equity swaps.

Given low deposit rates and a lackluster property market, a moribund stock market leaves few avenues for ordinary savers to generate returns. In addition, a market decline would compound the effects on corporate balance sheets and eventually the economy’s performance, something hitherto invincible government planners can’t have.

Margin buyers stampede for the exits

It remains to be seen if the authorities can pull it off. But what the events of recent weeks have proved is that the punters are suspicious. Leveraged buying – allowing retail investors to borrow from brokerages in order to invest in stocks – doesn’t get along with volatile markets. They appear to be paying back their margin loans and getting out.

The balance of margin financing at Chinese brokerages has nosedived despite relaxed margin rules unveiled by regulators to attempt to arrest the one-way market slide. Battered retail investors continue to go back to the brokers and return vast amounts of money -- nearly RMB600 billion of borrowed funds -- in just the first five days of trading during July.

As of the July 8 market close, the margin loan balance fell to RMB1.46 trillion, only 64 percent of the RMB2.27 trillion peak on June 18. On July 8 alone, the margin loan balance fell by a single-day record of RMB170.3 bn. To offset that decline, the state-owned margin loan lender China Securities Finance Corporation actually received funds from the central bank and sent RMB200 billion of subscription orders onward to five fund managers. Reports indicate the order was for actively-managed funds, meaning they aren’t just limited to blue chip ETFs or large cap stocks. Small and mid-cap stocks are now being included in the government buying program.

Since July 2, Beijing has ordered at least 30 separate actions ranging from propping up brokers to pouring money into the markets to ordering brokers to continue market financing, dragooning companies into taking 40 percent of the stocks in the market off the table – which only put pressure on the rest – canceling IPOs and doing whatever possible in what seems like an increasingly desperate atmosphere.

Canute commands the waves to stop

Market reports suggest that if the situation warrants, regulators are considering a hard floor at around 3300 for the SHCOMP, the point at which government-controlled funds would meet all sellers to prevent the index from going any lower. Clearly, there will be still some time to go before the market restores its natural balance. At this juncture, it is interesting to note short-sellers have basically gone extinct as outstanding interests for stock borrowings have crashed 75 percent from their peak to a minuscule RMB2.51bn. That demonstrates that despite the patchy, uncoordinated and highly criticized policies being rushed out by Chinese financial regulators, the risk-reward for going against the state is not worth the effort. The markets have responded by recovering. But how long that can continue is questionable and analysts are warning of months of volatile trading. It depends on how deep Beijing’s pockets are. Here, courtesy of the Hong Kong-based REORIENT Securities Ltd. is a list of actions taken to attempt to win back investors.

Date Bailout action Details Jul. 9 CIRC prohibits insurers from unilaterally forcing brokers to pay back money Reasonable payback deadline settled for creditor rights transfer and repo business of margin financing Police investigate malicious short selling Ministry of Public Security cooperates with CSRC to find out malicious short selling clues CBRC bailout measures 1. Allow banks to re-negotiate terms of due stock pledges with clients 2. Support adjustment of risk warning threshold and position-closing threshold 3. Encourage banks to cooperate with CSF and provide financing 4. Support banks to provide pledged financing for listed companies involved in share repos Jul. 8 CSF buys shares of five active public funds 1. RMB200 bn is evenly distributed to Chinaamc, JSfund, three other funds 2. Since active funds invest in almost all stocks, liquidity injection is a signal to bolster SME stock price CSRC urges major shareholders of listed companies not to cut holdings 1. Shareholders with 5% or above holdings and senior managers are prohibited from cutting holdings within six months 2. SASAC requires consistent holding of central SOEs RMB260 bn credit quota for 21 brokers China Securities Finance Co provides RMB260 bn credit for 21 brokers via equity pledge PBOC says it will offer ample liquidity to China Securities Finance Co Channels include interbank lending/borrowing, financial bond issuance, collateral financing, re-lending China Securities Finance Co will escalate share purchase of small- and medium-cap companies Aiming to relieve tight liquidity resulting from panic short selling CSI500 Index short position margin upgraded from 10% to 20% Will be further improved to 30% as of Jul. 9 CIRC to increase limit for insurers' investments in blue chip stocks Up to 10% of total assets can be invested in blue-chip stocks, previous limit is 5% China Securities Finance Co. to issue RMB80 bn short-term bonds on interbank market CITIC reportedly serve as leading underwriter China Life, PICC invest RMB50 bn in blue-chip ETF N/A Jul. 7 Limit arbitrage withdrawal quota China Financial Futures Exchange (CFFEX) limits arbitrage withdrawal quota to 500 times RMB50 bn reverse repo PBOC conducts RMB50 bn reverse repo at 2.5% Home provident fund bailout expectation Up to RMB900 bn fund may be invested in equity market CFFEX limits CSI500 ETF transaction volume China Financial Futures Exchange (CFFEX) limits CSI500 ETF one-sided daily transaction volume to 1200 Jul. 6 Multiple futures companies restrict short selling Short sellers are not allowed to open positions Complete short sell restriction on social security portfolios All social security portfolios are only allowed to buy shares Guosen securities purchases blue-chip ETFs Guosen securities announces investing RMB6.59 bn in blue-chip ETFs Chairman of 42 Hunan listed companies promise no holding cut this year 42 listed companies (52% of entire listed companies in Hunan) promise no holding cuts before yearend, determined to support market expectation 57 public fund companies invest in equity funds (by 8 p.m., Jul 6) 1. 57 fund companies invest RMB2.16 bn in their own equity funds 2. Senior managers invest no less than RMB500K Jul. 5 Central Huijin adds ETF holdings Central Huijin announces recent ETF purchase on secondary market, will continue related operation Jul. 4 RMB120 bn bailout by 21 brokers 1. No holding cut on self-operated equity portfolios if SHCOMP Index is below 4500 2. Promote brokerage share repo 3. Adjust margin financing indicators and smooth client defaults under risk control IPO suspension 1. CSRC postpones 28 IPOs, over RMB1 trn estimated to be refunded 2. No suspension of new IPO reviews 3. Slash new IPOs and funding value, punish malicious short sellers Joint bailout by public funds 1. Open up purchase of previously-restricted funds 2. Accelerate equity fund registration and issuance 3. Senior fund managers promise to buy and hold their companies' equity funds for at least one year RMB250 bn MLF rollover PBOC rollovers RMB250 bn MLF for another six months, interest rate 3.35% to maintain sufficient liquidity Jul. 3 CSRC boosts registered capital of China Securities Finance Co to RMB100 bn 1. China Securities Finance Co., the only refinancing business provider for Chinese brokerages, is allowed to expand registered capital from RMB24 bn to RMB100 bn to stabilize capital market 2. PBOC will offer liquidity to CSFC via multiple forms Jul. 2 PBOC Governor speech PBOC Governor Zhou stresses bottom line to avoid systematic risk Jul. 1 CSRC relaxed previously strict margin trading rules 1. Credit account holders with less than RMB500,000 of securities assets, a threshold for margin trading, are now permitted to continue margin trading 2. Brokerages with more-than-permitted margin trading size (4x broker’s net capital) could maintain the current level 3. Brokers are able to roll over margin trading contracts with clients according to their creditability, as long as the maximum term does not exceed 6 months 4. Rule requiring investors to produce additional collateral in two trading days if ratio of capital borrowed from brokerages reaches 130% of warning level is cancelled. Both sides can decide through discussion instead of compulsory sell-off Brokerage funding channels expanded CSRC also expands brokerage funding channels by permitting all brokers to 1) issue and transfer short-term corporate bonds via two major stock exchanges or trading systems between institutions, and 2) conduct asset-backed securitization based on margin trading A-share transaction fees slashed by 30% China's two major stock exchanges and CSDC plan to lower securities transaction fees by 30% to 0.0487‰, A-share transfer fees by 33% to 0.02‰ for buyers and sellers. The cost-cut policy is believed to boost market confidence and stabilize stock market Beijing Zhongguancun listed companies association calls for major shareholder holding 1. Cover 277 listed companies in Zhongguancun 2. Encourage major shareholders to add equity holding, conduct share repo, urge no holding cut by senior managers RMB300 bn insurance fund set up 1. First batch RMB100 bn 2. Mainly to invest in Road Belt Plan, regional integration 3. CIRC calls for net buying from insurance fund Jun. 29 Central Huijin reportedly invests RMB9.34 bn into four blue-chip ETFs 1. China 50 ETF (510050 CH): RMB1.59 bn 2. Shanghai SSE180 ETF (510180 CH): RMB3.62 bn 3. Huatai-Pinebridge CSI300 ETF (510300 CH): RMB3.19 bn 4. China AMC CSI 300 Index ETF (510330 CH): RMB946 mn Pension fund investment directives seek public opinion Up to 30% of pension funds, or equivalent to RMB1 trn liquidity may flow into equity market Jun. 27 Interest rate and RRR cut 1. PBOC cuts interest and lending benchmark rates by 25 bps 2. Conduct 50 bps targeted RRR cut for qualified banks in agricultural and micro lending, 300 bps RRR cut for financial firms Source: SINA, REORIENT

Steve Wang is chief China economist for REORIENT Securities Ltd.