SHANGHAI--China has signaled the imminent launch of a trial in which brokerages can borrow cash via a centralized intermediary to relend to their clients for margin trading, a widely expected move to inject funds into a sluggish domestic stock market.
But China has put on hold a plan to allow short selling--bets that stocks will fall in value--via the intermediary at a time when the markets have been under selling pressure, people familiar with the situation told Dow Jones Newswires on Tuesday.
Detailed rules on the new trial for margin trading, in which investors buy stocks with borrowed money, and short selling were published late Monday on the website of China Securities Finance Corp., the centralized intermediary that was set up in October 2011. While the rules cover both activities, short selling won't be allowed in the trial for now, the people said.
China has restricted brokerages to using their own cash to fund margin trading and lending securities to investors for short selling since it began to allow these market activities in 2010. China Securities Finance Corp. was set up to arrange loans of money or securities, both its own and those borrowed from other entities, to the brokerages for these purposes.
Eleven brokerages have been selected to participate in the trial.
The state-run Securities News on Aug. 14 cited unnamed sources as saying that the securities companies are Haitong Securities Co. (>> Haitong Securities Co., Ltd.), Guotai Junan Securities Co., Citic Securities Co. (>> CITIC Securities Company Limited), Huatai Securities Co. (>> Huatai Securities Co., Ltd.), Shenyin Wanguo Securities Co., China Galaxy Securities Co., China Merchants Securities Co. (>> China Merchants Securities CO., LTD.), GF Securities Co. (>> GF Securities Co Ltd), Everbright Securities Co. (>> Everbright Securities Co Ltd), Guosen Securities Co. and China Securities Co.
Trading on margin magnifies the potential gains for investors if shares rise, but deepens losses if they fall. In short selling, an investor borrows securities from a broker in order to sell them, hoping to buy an equal number of shares later at a lower price to replace the borrowed stock and pocket the price difference.
China's stock market has been criticized for lacking tools to hedge against risk when the market falls and for its low leverage ratio, a measure of how much investors are borrowing for stock market investments compared with their total assets, due to stringent regulations.
The rules include risk controls such as a halt to margin trading and short selling via the intermediary if China Securities Finance Corp.'s net capital shrinks to 100% of its risk-capital reserve. Trading can resume in the following session if the ratio climbs back to no less than 120%.
Also Monday, the stock exchanges in Shanghai and Shenzhen released their own rules on the lending of securities for the trial. China Securities Finance Corp. can borrow securities from the two exchanges, and only institutional investors can lend securities to the intermediary, according to the regulations.
The planned trial comes as the benchmark Shanghai Composite Index is trading at three-and-a-half year lows amid concerns over a prolonged economic slowdown in China. The Shanghai index has fallen 6.4% so far this year, compared with a 7.4% rise in Dow Jones Industrial Average over the same period.
The trial is part of Beijing's efforts to deregulate its rigid financial system and allocate capital and resources more efficiently, including allowing interest rates to float in a wider range and lowering the bar for foreign investment in the country's capital markets.
An increase in trading on credit will help increase trading volumes in the stock market while boosting brokerages' revenue, analysts say.
China Securities Finance Corp. has registered capital of 12 billion yuan ($1.9 billion), indicating investors can borrow up to CNY120 billion from the intermediary to fund their trading on margin. Its shareholders include the Shanghai Stock Exchange, the Shenzhen Stock Exchange and China Securities Depository & Clearing Corp., a national securities clearing agency.
Margin trading and short-selling transactions on the Shanghai and Shenzhen stock exchanges totalled CNY67.3 billion as of Aug. 27, of which margin trading accounted for CNY66.0 billion, or 98% of the total number.
In 2010, China started to allow qualified brokers to conduct margin trading and short selling using their own money and securities on a trial basis. Eighteen months later, it lowered the bar on the entry of brokerage firms, allowing more brokers to engage in trading on credit.
As of Aug. 15, 69 brokers and more than 329,500 investors have registered for margin trading and short selling, the Shanghai Securities News reported last week, citing data from China Securities Finance Corp.
Margin trading and short selling businesses generated a combined CNY2.16 billion of income for brokerages in the first six months of this year, or 9.5% of the sector's net profit, data from the Securities Association of China showed.
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