Just three days ago, we outlined the series of events [9] that ultimately led Beijing to transform China Securities Finance Corp into a half-trillion dollar, state-sponsored margin trading Frankenstein.
To recap, two weeks ago the PBoC said it was set to inject capital into China Securities Finance Corp., which is effectively a subsidiary of the China Securities Regulatory Commission. "China’s central bank is now underwriting brokerages’ margin lending businesses," we said, before driving the point home with this: "The PBoC is now in the business of financing leveraged stock buying."
Since then, the plunge protection funds channeled through the CSF have ballooned and on Friday, China’s commercial banks agreed to lend another CNY209 billion to the margin finance vehicle. All in, the CSF has around $483 billion in available funds it can use to "support" Chinese stocks.
Amusingly, China sounded the all clear on Monday as officials claimed that "timely measures" had arrested (perhaps literally) the panic and restored "order" to the market. If "order" means the conditions which persisted prior to June, then we suppose margin trading that totals nearly 20% [10] of the free float market cap and straight-line, limit up buying is just around the corner.
China is apparently so confident that three week’s worth of unprecedented (and comically absurd) intervention has stabilized the situation and repaired what we still contend is irreparable damage to the collective psyche of the Chinese retail investor, that the PBoC is set to wind down the CSF’s plunge protection activities just days after several commercial banks pledged billions more in support for the margin lender.
The CSRC is "studying stock stabilization fund exit plan," Bloomberg reported on Monday morning, citing Caijing. The market’s response was not favorable:
Although Chinese stocks closed green [12] after the CSRC said it would "continue to focus on stabilizing [the] market and preventing systemic risks," it seems clear that China’s unsustainable equity bubble is ... well, rather unsustainable without explicit government support.
That of course is bad news for China in terms of its push to liberalize markets and promote the yuan in international investment and trade by projecting an air of stepped up transparency and market-based reforms.
BofAML has more on why Beijing’s attempts to support equities will ultimately fail (note the reference to the "broken spell" which is another way of saying what we said weeks ago about the change in retail investors' mentaility) and on the negative effect intervention has on China’s international reputation.
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From BofAML
The A-share market may see another leg down within months
Forces holding up the market may not last long
In our view, the short-term stability in the A-share market was achieved at the expense of: 1) the government’s reform credentials and 2) the wallets of state-directed entities, including brokers, banks, insurers and the PBoC. Faced with relentless selling pressure, neither of these two can last long, in our opinion. As a result, we expect the market to experience another leg down, possibly within months.
The price for the short-term market stability is heavy.
Essentially, how the government stabilized the market was by limiting selling activity and then using state-directed money to buy broadly in the market (Table 1, a detailed list of the government’s market-supporting measures since late June). At the peak, roughly half of the A-shares were suspended from trading (Chart 1) and the police heavy-handedly investigated selling activities, especially in the index futures market. Meanwhile, banks may have provided an Rmb2tr credit line, in addition to the PBoC’s lending, to the China Securities Finance Corp (CSFC) for it to buy stocks directly or indirectly. Based on media reports, CSFC had probably spent at least Rmb860bn by Jul 17 to support the market.
Reform credential is important to the government.
What happened in recent weeks has made many question the government’s reform resolve. As a result, we believe that the government’s desire to roll back the administrative controls is strong.
Given the expensive market valuation, the Prisoner’s Dilemma dictates that most state directed buyers may want to stop buying and reduce their stock exposure as soon as possible. That means that the buyer of the last resort will be the PBoC, via direct lending to the CSFC or by underwriting bank loans to the CSFC. If this practice persists for long, it may do the PBoC’s reputation irreversible damage and hurt RMB’s globalization. In addition, loans to the CSFC may crowd out bank lending in the real economy by using up their loan quotas.
Selling pressure will likely remain relentless.
Now that the spell is broken, we expect that many holders may want to sell to the forced buyers in the market. In addition, although difficult to assess accurately, due to a lack of data, we estimate that around 1/5 of the free float is still carried on margin. The high margin cost means that selling pressure is high as long as investors do not expect the market to go up significantly.


