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Marginal gains

27 May 2015 By Peter Thal Larsen

The main fuel for China’s stock market boom is running low. Borrowed money helped the Shanghai and Shenzhen stock exchanges double in value in six months. Despite frantic fundraising by brokerage houses, however, demand for leverage may be nearing its limits.

Chinese stockbrokers are the clear beneficiaries of the mainland stock-buying frenzy. Investors’ new-found love for margin trading – financing equity purchases by borrowing against the value of the underlying shares – adds extra spice. The balance of outstanding margin loans has almost doubled since the end of last year to reach 1.9 trillion yuan ($300 billion), according to Fitch.

Breakneck growth in this lucrative but capital-intensive business has sent securities firms scrambling to raise new funds. Hence outfits such as GF Securities, Galaxy Securities and Haitong have issued equity worth more than $10 billion this year. At Huatai Securities, the Nanjing-based broker currently completing a $4.5 billion Hong Kong fundraising, margin-related lending and trading accounted for 28 percent of revenue in the first quarter, up from just 8 percent in 2012.

However, there are several reasons the leverage boom may have a limited life. First, debt levels are already high. Margin balances are now equivalent to more than 3 percent of China’s total market capitalisation, according to Macquarie analysts. Exclude shares held by the Chinese government and other controlling investors, and the ratio rises to a staggering 8.9 percent.

Second, the number of investors eligible for margin trading is also finite. Huatai had about 212,000 margin accounts at the end of March, out of 6.8 million retail clients. But the broker estimates only another 163,500 accounts have the minimum balance of 500,000 yuan required to qualify for margin trading. Add in the ever-present threat of further regulatory restrictions, and the scope for expanding margin trading looks limited.

As China’s capital markets expand and open up, brokerage firms are well-placed to evolve into full-fledged investment banks. But revenue from underwriting bond issues or advising on takeovers is still relatively small. When the fuel of borrowed money runs out, securities houses will need to find more durable sources of income.


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