Writing in the Journal of International Banking Law and Regulation Lerong Lu and Lu Longjie, both from the University of Leeds, provide the clearest account I’ve seen to date about how regulators in China lost control of margin finance in 2014 which led to the spectacular bull and bust market that followed in Chinese A-shares.
It was indeed a spectacular bull market, both in terms of it’s scale and it’s speed. From July 2014 to June 2015 the Shanghai Stock Exchange Composite Index (SHCOMP) gained 2,000 points, more than doubling in the process.
The convulsions that followed were equally spectacular. After the botched currency revaluation in August 2015 the market appeared to stabilize; but worse was to come. The dry retching finally concluded in January 2016 but in the process China had rocked the world’s other major markets and a belief in regulatory omnipotence was in tatters. As you can see from the chart above 18-months on the SHCOMP may have recovered some poise but has, as yet, shown no interest in joining the party going on in the world’s other major stock markets.
The paper contributes usefully to an understanding of this process leveling blame squarely on credit and describes how this factor in the equation, present from 2010, got so out of hand. The authors describe how ‘Umbrella Trusts’ were worked, how sophisticated software allowed for multiple blind accounts to be operated at brokerages and how the introduction of shadow lenders offering 5:1 finance acted as a corrosive accelerant.
The authorities are given some credit for having the situation under review in 2015 but the speed and force of events overtook them. Eventually, as we now know, they got on the case; but in the process severely damaged any pretense that ‘market forces’ would play a greater role in capital markets as they had trumpeted would be the case for some time prior to the debacle.
It’s beyond the scope of the paper to speculate what happens now. We investors must try and work that out. Given the fact that losses suffered by many, due to leverage, will be many times larger than a simple calculation based on market moves would imply I’d reckon on torpor being the default setting in A-share land for some time to come.
You can access the paper in full via the following link China: Margin Financing.
Happy Sunday.