By Chao Deng
Concern is growing over a surge in bets by mom-and-pop investors
using cash borrowed from brokers to pile into, and fuel, China's
booming stock market.
Margin lending has more than tripled in the past year to a
record 1.7 trillion yuan ($274.6 billion), according to WIND
Information Co., a provider of financial data. The upsurge echoes
past investment crazes among Chinese speculators, who have long
shown a penchant for rushing into whatever is yielding the highest
returns, from real-estate and wealth-management products, to
bitcoin and online money-market funds.
The practice isn't unique to China, where margin debt equals
3.2% of total market capitalization, compared with 2.3% in the U.S.
But when compared with the value of stock that is freely traded,
making it accessible to ordinary investors, the percentage for
China rises because state entities own more than half of the
market.
Research by Macquarie Securities Group shows China's margin-debt
ratio at 8.2% of the free float. That easily exceeds the peak of 6%
reached in the late 1990s in Taiwan, the second-highest level
globally in recent years.
"There's a huge amount of leverage built in," said Matthew
Smith, a Shanghai-based senior analyst at Macquarie. The reliance
on debt points more to a potentially volatile market than a pending
collapse, but the comparison of leverage to the size of the market
that retail investors can actually access is a "reality check" for
risks in the current rally, he said.
Along with several rounds of monetary easing from China's
central bank that have pumped billions of yuan into the financial
system in recent months, margin lending has helped stoke an
explosive market. The Shanghai Composite Index rose 53% last year
and another 36% this year.
"It's definitely not sustainable for us to trade up the market,"
said Yuming Ying, a fund manager at Hong Kong-based China Eagle
Asset Management Ltd. "There's quite a lot of local reports
pointing to high levels of margin trading. It is quite dangerous.
You really don't know when it will stop."
Local investors have leveraged up their bets on smaller stocks
on the mainland in particular, adding risk to an already volatile
portion of the market.
Trading funded by margin loans accounts for 25% of daily volume
on the ChiNext, the market in Shenzhen where Chinese startups
trade, according to estimates from UBS AG. There, local investors
have rushed to buy firms purported to have huge growth potential,
pushing the ChiNext benchmark up nearly 80% this year to
record-high valuations.
Turnover from margin-financing accounts makes up 15% of daily
trading volume in the total mainland market, UBS estimates.
Still, even if the rally starts to fade, strategists and
investors say the triggering of margin calls, when brokerages force
their investors to sell in order to recover their original loans,
isn't likely.
Brokerages generally ask their investors to add collateral when
the ratio of invested money to borrowed money reaches 1.5 times,
and automatically close out positions if the coverage ratio falls
to around 1.3 times. Assuming a Chinese investor had invested the
minimum 500,000 yuan needed to start a margin-trading account and
borrowed the same amount at the beginning of the year, the market
would have to fall roughly 50% from its current level for the ratio
to fall to a level where the broker would force selling.
"[It's] not particularly likely, especially given the 10%
[daily] down limit" on stocks imposed by Chinese authorities, said
Macquarie's Mr. Smith. Investors would begin selling before
coverage ratios fell that low, he said.
One danger is that those who bought early on, seeing their
stocks surge, would take on even more loans to invest further.
Macquarie estimates the average coverage ratio of margin traders in
China is currently 2.6 times, up from this year's low of 2.3 in
early February. Margin loans could increase to 9.4 trillion yuan
from the current 1.7 trillion, before the average coverage ratio
would hit 1.3 times, according to the bank.
Authorities have stepped in numerous times since December to
rein in borrowing at brokerages, issuing warnings and even
suspending the opening of margin-trading accounts at selected
firms.
"If there was a lot of aggressive business practice amongst
brokerages, regulators would be likely to step in again," said UBS
China strategist Wenjie Lu.
Investors also say increases in the amount of cash in the
financial system have made more money available for stock
investing, providing support to the market. The daily trading
volume on the Shanghai stock exchange surpassed 1 trillion yuan for
the first time on Monday.
Still, Mr. Ying said he started selling out of his investments
in mainland stocks in December because margin trading by local
investors had been a big reason behind Shanghai's steep rally.
China Eagle continued to offload stocks even after authorities
stepped in to curb margin lending in January.
Mr. Ying admitted that he sold early, missing much of this
year's gains, but he said that trying to predict and time changes
in the behavior of mainland investors is tricky. "Chinese investors
are probably too optimistic," he said. "Reforms can't make a
difference too quickly, while Western investors are too
pessimistic. The market won't crash with the amount of foreign
reserves authorities have."
Gregor Stuart Hunter contributed to this article.
Write to Chao Deng at Chao.Deng@wsj.com