Pursuant to the latest document of the Chinese top authorities, the leverage ratios for margin trading on China's domestic stock market are expected to be lowered in the coming five years, which analysts and investors believe is to guard healthier and steadier development of the market.
The Communist Party of China (CPC) Central Committee's "Proposal on Formulating the Thirteenth Five-year Plan (2016-2020) on National Economic and Social Development," which was adopted at the Fifth Plenary Session of the 18th CPC Central Committee ended Oct. 29, suggested cutting down the leverage ratio in share trading.
According to the proposal, China should actively foster a transparent and healthy capital market by pushing forward reform on the issuing and trading systems for stocks and bonds, raising the proportion of direct financing and reducing the leverage ratios. This is the first time for the Chinese top authorities to clarify in a state-level development plan that the leverage ratios should be reduced.
Many market insiders deem that such expression is made to tackle the disorderly growth of the leverage ratios in 2015 that caused abnormal swings of the stock indexes so as to prevent systematic financial risks. Margin trading and short selling business is a leverage investment instrument on Shanghai and Shenzhen bourses introduced in five years ago.
As an innovation business, such business has played a significant role in promoting market dynamism, intensifying the fundamental systems of the capital market, enriching the securities trading modes, consolidating the internal basis of steady market operation and increasing investment yields for investors.
After it debuted on Shanghai and Shenzhen bourses on March 31, 2010, the balance of margin financing kept on rising year by year. The daily margin financing volume was less than ten billion yuan before the start-up of the previous bull run in July last year. But the figure suddenly shot up some 20 times to reach 60 billion-100 billion yuan in last November after the central bank's interest rates cut. The pace of expansion quickened later along with the bull run on the domestic stock market. The margin financing balance soared from around 420 billion yuan in July 2014 to as high as more than 2.2 trillion yuan in June 2015. Such fast expansion largely boosted market sentiment and pulled up stock prices on the two exchanges, lifting the benchmark Shanghai Composite Index from a low of some 2,000 points to a peak of 5,178.19 points from July 2014 to June 2015, the biggest bull run since 2007. Besides, huge amounts of irregular margin finances appeared along with the market buoyancy, further fanning the bull.
The rally of the market further enhanced investors' enthusiasm for engaging in margin trading in pursuit of high yields, thus, the leverage ratios for such trading was pushed up significantly. Along with upsurge of the stock prices, the leverage ratios were driven up quickly with those provided by private financial institutions reaching as high as four to five times, or even higher as negotiated by the lenders with the borrowers, while regulated margin financing services by qualified securities companies offered a leverage ratio of only 1.5 times.
High-leverage risks accumulated on the market and finally led to quick plunges of stock prices since the middle of June 2015, with the Shanghai Composite Index falling by a maximum of nearly 50 percent in just about two months. During the process of market decline, related authorities took a flock of measures to push forward de-leveraging on the market and stabilize market sentiment, including injecting liquidity, banning major shareholders from cutting positions and cracking down illicit trading accounts and financing activities, which was blamed for causing this round of market falls.
Securities companies also raised their guarantee ratios for margin trading and short selling business so as to ward off risks. In September, de-leveraging on the domestic stock market saw periodical progress with the margin financing balance contracting from some 2.2 trillion yuan in June to some 1.1 trillion yuan.
The performance of the stock market became relatively moderate as compared with that in the first half of 2015. Besides, irregular margin finances were squeezed out of the market. Lin Caiyi, chief economist with Guotai Junan Securities, points out that reducing the leverage ratios as mentioned in the proposal on China's 2016-2020 development plan actually reflects related authorities' decision to restrain excessive speculation on the stock market so as to ease market fluctuations.
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