Chinese stockholders have been increasing their borrowing against shares, driving revenue for broker-dealers, but ultimately creating more risk in the event of a market downturn.
Shareholders in 317 Shanghai and Shenzhen-listed companies pledged shares worth at least 40 percent of those companies by December 18, up from 224 companies on the same date a year earlier, according to Wind Info, the Chinese financial data group.
Share pledging is common for small and mid-cap companies, where a single shareholder often owns a large stake. Controlling shareholders often reinvest the proceeds by buying additional company shares on the secondary market to boost the share price. Interest income from the sale and repurchase of financial assets – a category that typically comprises loans against pledged shares – rose 25 percent in the first half of 2017 from the same period in 2016 at 29 mainland-listed brokerages, according to Wind Info.
But it has been observed by market commentators that share pledging can amplify a market downturn. If a company’s share price drops below a designated ‘stop-loss level’, the lender will liquidate the pledged shares, pushing the share price down even further. Liquidation of pledged shares was seen as a contributor to a steep drop in Hong Kong’s small-cap Growth Enterprise Market in late June 2017, when 17 stocks fell by more than 40 percent in a single day.
In September, China’s two main bourses, the Shanghai Stock Exchange and the Shenzhen Stock Exchange, published draft rules that would tighten regulation on share pledging. One provision caps the value of loans secured by shares at 60 percent of the market value of the pledged shares, ensuring a buffer that will protect the lender in case a share price falls. How this plays out in 2018, only time will tell.
