This page has been archived and commenting is disabled.
The Complete Guide To China's CNY 4 Trillion Margin Doomsday Machine
On the heels of a veritable bloodbath in Chinese equities overnight which saw the SHCOMP slide a harrowing 8.5%, the entire world is now beginning to take a hard look at the notion that dramatic bouts of selling pressure are aggravated and perhaps triggered by an unwind in the multiple backdoor margin lending channels that allowed investors to skirt official restrictions on leverage and helped to drive the market’s world-beating rally.
On Sunday night, before the carnage began, we outlined each of seven margin channels and presented an estimate (via BofAML) of just how big the ‘problem’ is. Here’s the table which shows that between official margin financing, stock collateralized lending, umbrella trusts, stock benefits swaps, structured mutual funds, P2P and offline private fund matchings, nearly CNY4 trillion in margin lending stands behind the Chinese market.
As you can see, official margin lending has fallen to CNY1.4 trillion after peaking above CNY2 trillion, but there’s still an exorbitant amount of leverage built into the system via the country’s shadow financing edifice. Below, you’ll find the complete breakdown of each channel, courtesy of BofAML.
* * *
From BofAML
The seven quantifiable leverage channels
Margin Financing (MF): Rmb1,455bn
This is the most transparent part of the leverage in the stock market with CSFC announcing the outstanding balance on a daily basis. The balance peaked on Jun 18th at Rmb2,267bn and has since declined to Rmb1,455bn by July 23rd (Chart 1 & 2).
MF is largely funded by banks via bank wealth management product (WMP) and brokers via their own funds and their Targeted Asset Management programs (TAM) – Exhibit 1. Although the government forbids banks to directly lend for stock purchase, it allows banks to do so indirectly via WMP because, in theory, banks do not bear losses if WMP loses money (more on this latter), and buyers of WMP are supposed to be reasonably sophisticated.
Stock Collateralized Lending (SCL): approx. Rmb900bn
Holders of listed stocks can go to brokers, banks and trust companies to obtain a loan, using the stocks as collateral. Although in theory the borrowers can use the obtained funds for many purposes, we suspect that in recent times most of them used the funds to invest in the stock market, sometimes by buying the very stocks they used as collaterals to drive up their prices. It appears to us that potential margin calls from this lending source is one of the main reasons why, at the height of the A-share market crash, close to half of the A-share companies had their stocks suspended from trading
Umbrella Trust (UT): approx. Rmb600bn
UT allows the senior tranche investors (the more risk-averse ones) to lend to the junior tranche investors who buy stocks. Usually, the senior tranche investors will get a fixed return of 8-9% p.a., and the trust companies will get a 1% fee. Leverage of the junior tranche is normally capped at 3x with a cut-loss clause.
Structured Mutual Fund (SMF): Rmb473bn
SMF commenced in in 2007. The structure of SMF is similar to UT with the senior tranche providing financing for a fixed return and the junior tranche taking on leverage to invest in the market. Buyers of both tranches tend to be retail. According to Fund Industry Association, 38 mutual fund management companies had set up 117 stock-focused SMFs by June 2015, with an outstanding AUM of Rmb473bn. These funds can invest in the mainboard, GEM board and ChiNext, depending on their mandate. CSRC caps the junior tranche’s leverage at 2x when the fund is initiated, and 6x during its operation. By June 22, the average leverage is at about 1.9x.
* * *
Note that we have discussed both umbrella trusts and structured funds extensively.
Here’s how we described the trusts: An umbrella trust is set up like a CDO. The senior tranche is sold by banks to clients who receive a fixed payout (like a coupon payment), only instead of CDS premiums (in the case of a synthetic structure) or cash flows (from a cash structure), the ‘coupon’ payments are generated by equity investments in the subordinated tranches, which are used by brokerages to skirt margin restrictions. In other words, the guys holding the senior tranches are financing the stock trades of the guys in the junior tranches. Here's a schematic with a bit more detail:

And as for structured funds, recall that these are the vehicles which caused China’s young gun fund managers (the "E*trade babies" as we called them) to get into so much trouble, with losses in some funds totaling 80%. Here's a concrete example from WSJ:
Retail investors and even some institutions like structured funds because they have earned outsize returns and it is an easy way to leverage their investments without having to borrow from securities firms or banks.
The funds are usually divided into two or more tranches.
With structured funds, the B-tranche is typically forced to sell stocks and lower leverage in a falling market, to protect the interest of the A-tranche fund investors. This has accelerated stock declines and exacerbated B-tranche losses.
The May 27 launch of the 246-million-yuan ($39.6-million) Peng Hua High Speed Railway Fund, the third-worst performer the past month among China’s 2,879 mutual funds, according to Howbuy.com, is especially ill-timed.
High-speed rail was a hot investment theme, but many of those stocks are now down 60% from their recent peaks.
The Peng Hua High Speed Railway Fund is managed by Jiao Wenlong. Mr. Jiao... He became a fund manager on May 5, the prospectus said.
And now back to BofAML for a rundown of the remaining backdoor margin lending channels, starting with the "SBS" (which is a lot like a total return swap) and continuing through P2P lending.
* * *
Stock Benefit Swap (SBS): approx. Rmb500bn
SBS is often referred to as institutions’ margin financing facility. The essence of the transaction is for brokers to buy stocks or stock indices in the secondary market (sometimes IPOs, placements, commodities or other financial instruments), using their own resources and then swap the floating return for a fixed return with an institution, such as a fund, a corporation, an insurer or a major shareholder in a listed company. To mitigate risks, brokers normally require the counterparties to put up margins and also sign a cut-loss agreement. Exhibit 3 illustrates how such a deal might work in practice for both lenders and borrowers.
P2P & offline fund matching service: approx. Rmb200bn
During previous rounds of market rallies, fund matching service tended to be the key form of unofficial leverage. The service has been prevalent in Jiangsu and Zhejiang where there is significant private wealth. With the financial deregulation in recent years and the flourishing of many readily available forms of leverage as mentioned previously, the relative importance of private fund matching service has diminished a great deal. Nevertheless, the absolute size is probably still meaningful, particularly after the introduction of platforms like HOMS that has made risk control by lenders easier. Data here is murky. Some local experts estimate the scale at about Rmb200bn, including the online portion, which sounds about right to us. A fairly new phenomenon is the online fund matching service, mostly P2P . Local media reported that there are more than 60 P2P platforms specializing in fund matching for stock investing and many were set up in the past 6 months. The entry barrier is quite low: a website’s software and hardware cost is around Rmb0.5mn and regulation is light. These platforms mainly cater to small lenders and borrowers with loan size around Rmb2-30k per deal and duration ranging from 2-30 days. In contrast, the deal size for offline fund matching is typically over Rmb1mn.
* * *
So what does all of this mean for Chinese stocks?
First, it means that, as we saw on Monday and as we said rather prophetically on Sunday evening, "the important point is that the unwind has probably just begun. In short: it seems unlikely that all of the leverage has been squeezed out of China’s exceedingly intricate shadow financing system."
And here's BofAML boiling it down: "leverage means relentless selling pressure."
Yes, "relentless selling pressure" as nearly CNY4 trillion in margin is unwound in a rather disorderly fashion.
And that spells trouble not only for China's millions of newly-minted day traders who will be forced to watch in horror as their life savings' are vaporized in a cascade of margin calls and forced unwinds that will ultimately trigger more days like Monday (and worse), but also for the broader economy, and also for the yuan. Here's BofAML again:
This means that most leveraged positions may suffer from losses ultimately, likely in Rmb trillions. On the other hand, the capital base of brokers and trusts, who are the first loss takers behind investors, is only Rmb1.6tr (Table 2). Banks’ capital may suffer greatly as well once the equity of the other FIs is depleted – banks provide or channel most of the leverage directly or indirectly. The risk is that the unwinding of the leverage will be disorderly – due to implicit guarantees behind most shadow banking financial products, investors could easily panic if they suffer from meaningful capital losses, by our assessment. The key risk to our view is that the government may be prepared to take on substantially all the leverage, in which case, we expect RMB or growth to come under pressure.
In other words, the risk to the margin unwind case is that the PBoC steps up its support via CSF and essentially restores margin lending to its pre-selloff levels. The obvious problem there is that after the bevy of steps Beijing has taken to support the market over the course of the previous month, the world is already highly skeptical of China's commitment to capital market liberalization. Any move by Beijing to go full-interventionist (or "full-Kuroda" as it were) may imperil not only China's bid for A-share inclusion in benchmark EM indices, but the country's yuan SDR bid as well.
Of course, as we're fond of pointing out, if the country's farmers, housewives, hairdressers, and grandmothers decide not to go silently into that good night, resigned to having lost everything in what is looking more and more like a modern day tulip mania every day, then a crashing economy and international ostracization of the renminbi may be the least of Beijing's worries.
- 36340 reads
- Printer-friendly version
- Send to friend
- advertisements -







Varoufakis tapes released. Greece had a secret Plan B!
http://www.planbeconomics.com/2015/07/varoufakis-tapes-released-by-imf.html
If China lives by the (margin) sword, China will die by the (margin) sword.
<Another myth comes in for a hard landing, this one being that China will save the (economic) world.>
Transitory.
Transitory ghost cities.....
Spoiler alert for all the red neck China-will-create-a-gold-standard fanboys out there who have never been to China: the Chinese are compulsive gamblers and copiers.
They copy EVERYTHING the western world does (fiat banking, housing bubbles, stock market bubbles, Louis Vuitton bags) and then gamble away the spoils.
The Chinese WILL NOT reinvent the wheel, the Chinese (compulsive gamblers, remember?) WILL NOT limit themselves by any gold standard and no, this time it will NOT BE DIFFERENT!
Once upon a the US was considered a copycat...Even Charles Dickesn said so. After a while it started creating its own stuff. As a country grows, it first copies the current dominant empire., After it reaches a certain level, it starts getting creative.
So get off your high horse, The chinese can be just as creative as anybody else and I am not chinese,.
You'll have to consider the Chinese leadership is serious about their "Chinese Dream"
As opposed to the US that lives by the Fed balance sheet.
If China lives by the (margin) sword, China will die by the (margin) sword.
3.7 Trillion CNY = TARP. Do the math. They're just getting warmed up.
Wow! Stunning recording available at that link. What they discuss is not so shocking, per se, but the fact that it is recorded and available for all to hear is mind blowing.
So, why does China keep buying cheap gold?
I think their crisis is bullshit.
tl;dr.
just print moar money
double post
china isn't going to allow their fascist banks to suffer any more than the fascist maggots here in the usa will. that is to say not at all. viva la bonus!
You're right! They both (as well as most of the rest of the world) are part of the central banking system and will behave similarly.
getting tired of fighting it. i should just put it all in usa financial stocks and climb back into the matrix. fuck it.
Spoiler alert for all the red neck China-will-create-a-gold-standard fanboys out there who have never been to China: the Chinese are compulsive gamblers and copiers.
They copy EVERYTHING the western world does (fiat banking, housing bubbles, stock market bubbles, Louis Vuitton bags) and then gamble away the spoils.
The Chinese WILL NOT reinvent the wheel, the Chinese (compulsive gamblers, remember?) WILL NOT limit themselves by a gold standard and no, this time it will NOT BE DIFFERENT!
Devaluation coming. Slamming the doors shut in a fire.
When everything crashes, at the least the Chinese can still build their own TVs. Can the US do the same?
True, most manufacturing capabilty left the USA.
They might be able to tie shoe-laces after the next crash, if China wiling to export them.
China may yet save the world, by crashing it.
While the bubble is inflating people get the true joy of Capitalism.
Making money while doing nothing.
Markets are irrational and have been since Tulip Mania in 1600's Holland.
Do not look for rational explanations, the prospect of easy money turns human beings into gibbering idiots.
Stocks, house prices, <yet another asset type> are going up in value.
I have heard of someone who has made lots of money, I want in.
I am making money, I need to borrow money to carry on investing and make more money.
Gibber, gibber, gibber ....................................
The bubbles burst; I am going to be ruined.
No more gibbering, till next time.
Tulip bulbs ..... gibber
South sea company .... gibber
UK Railways (1800s) .... gibber
The new internet (pre 1999) .... gibber
Sub-prime ..... gibber
Property .... gibber
Apple .... gibber
Social media .... gibber
Emerging markets ... gibber
Easy money ..... gibber, gibber, gibber
No wonder the Chinese stock market went crazy.
The typical Chinese experience of Capitalism has been working in an Apple factory with suicide nets.
With the stock market boom, they could make money for nothing and get the true joy of Capitalism.
In the West, experience has made no difference, we still boom and bust and can't resist a bubble.
It is China’s first time, no wonder they went crazy.
“Capitalism’s free lunch, I love it” Chinese ex-Apple employee (last month).
Listen Elite fuckers and central planners.
If you let a market get out of control on the upside you can't do much when it turns and implodes.
You seem to always want nirvana, ever rising prices (often as quickly as possible) without the subsequent lower prices.
Chinese fucks are as dumb as the western ones which is not really surprising as we're all the same damn animal.
If there's one lesson to learn from this, it's the same lesson that was to be learned from the 1001 times its happened over the centuries -
IF YOU'RE NOT WILLING TO HAVE PROBLEMS WHEN A MARKET IMPLODES, DON'T LET THE FUCKER EXPLODE IN THE FIRST PLACE.
What's the odds on anyone in power taking that advice, about 100-1 on I'm afraid.
Thong
Ok Tin foil hat time..... With that large of a centrally controlled backstop, I find it hard to believe what I am seeing.... Wondering if this is some more of Gods work by the NSA or CIA, quote stuffing an index....
This "debt" is RMB debt. They don't owe it to external entities in the same way as Greece does for example. The CBC could probably bail everyone out to the tune of Trillions, and they still own trillions of USD and gold as reserves.
No, they owe it to people who will come and break their legs, chop off their hands, throw them off buildings, take their daughters to work in brothels. That RMB debt is really good stuff to have.
Yeah but honorary bonesman Mao implored the masses to multiply and today's 1.3B people need work so the state
made work even if it was making ghost cities and creating massive college graduate ant herds.
All these world leaders like Mao, Stalin, Franco ect were Black Nobility 33rd Deg Masonic, Zionist and Jesuit agents with a global control agenda. This would have never happened in a free market economy with genuine money.
Now we have a 7B world over-population problem with jobs for far fewer of them. It's a cluster and I just hope the survivors learn a lesson from all this deception from a few powerful men.