China: The disorderly deleverage may be over Tommy Xie OCBC Treasury Research & Strategy 09Jul2015
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China’s equity market rout •
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The benchmark Shanghai index lost almost one third value since the peak on 12 June while the small capped growth enterprise board fell by more than 40% from the peak on 3 June. Nevertheless, both indexes still gained year-to-date. Why is government stressed to defend the market when lots of investors are still making money?
5500
4400
5000
3900 3400
4500 2900
4000
Shanghai stock exchange
6-Jul-15
22-Jun-15
8-Jun-15
25-May-15
11-May-15
27-Apr-15
13-Apr-15
30-Mar-15
16-Mar-15
2-Mar-15
16-Feb-15
2-Feb-15
19-Jan-15
6-Jul-15
22-Jun-15
8-Jun-15
25-May-15
11-May-15
27-Apr-15
13-Apr-15
30-Mar-15
16-Mar-15
2-Mar-15
16-Feb-15
1400
2-Feb-15
3000
19-Jan-15
1900
5-Jan-15
3500
5-Jan-15
2400
Chinext Index
2 Source: BBG, CEIC, OCBC
Leverage led to high exposure of banks to equity market • •
The fact that regulatory framework did not keep pace with financial innovation led to the high exposure of banking system to recent equity market rally. Meanwhile, as a result of weak economic prospect, banks are more willing to lend to equity market due to protection from share collateral and margin.
Private Lending OTC
Margin Trading
Homs system + Umbrella Trust
Wealth Management Product
Banks Exchange
Brokers
Share Pledge Financing 3 Source: China news, OCBC
The meltdown started from unwinding of margin trading
160 140 120 100
80 60 40 20
Average PE ratio for Shenzhen SME
Jul-15
May-15
Mar-15
Jan-15
Nov-14
Sep-14
Jul-14
May-14
Mar-14
Jan-14
Nov-13
Sep-13
Jul-13
May-13
0 Mar-13
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The regulatory clamp down on OTC margin trading went out of control, which led to the vicious cycle of “correction-margin call-more correction-more margin call” Like all other bubble burst, the recent volatility also started from the valuation story. In China’s current context, it is not about the valuation for blue chips but about valuation for small and mid-capped stocks.
Jan-13
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Average PE ratio for Chinext
Source: BBG, CEIC, OCBC
It is a liquidity crisis
3500000
•
3000000 2500000 2000000 1500000 1000000 500000
The daily trading volume for benchmark index future IF1507 has spiked to about CNY2.5 trillion in the second half of June from merely about CNY50-100 billion in the first half of June.
6-Jul-15
2-Jul-15
30-Jun-15
26-Jun-15
24-Jun-15
19-Jun-15
17-Jun-15
15-Jun-15
11-Jun-15
9-Jun-15
0
5-Jun-15
•
3-Jun-15
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Once the correction starts, the buying interests for those expensive SME stocks suddenly disappear. Meanwhile, the 10% circuit break system further exaggerated drainage of liquidity. The poor liquidity and rapid decline gave those funds no time to get out of their losing positions. As such, they have to either hedge via their short index future positions or sell more liquid blue chips to meet liquidity needs. The government control on the futures market led to the sell-off of blue chips.
1-Jun-15
•
Daily trading volume for index future (July)
5 Source: BBG, CEIC, OCBC
Spill over to commodity, currency and bond markets •
China’s commodity futures have been sold off sharply during the market turmoil this week. The bond market also rang the alarming bell after brokers are reported to offload bond position for liquidity needs. Meanwhile, Chinese Yuan was also sold off in the offshore market although it remained stable in the onshore market.
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2.9
6.42
2.7
6.4
2.5
6.38
2.3 6.36
1.9
6.34
1.7
6.32
1-year Gov Yield
1 Year USDCNH forward
6 Source: BBG, CEIC, OCBC
7-Jul-15
5-Jul-15
3-Jul-15
1-Jul-15
29-Jun-15
27-Jun-15
25-Jun-15
23-Jun-15
21-Jun-15
19-Jun-15
17-Jun-15
15-Jun-15
13-Jun-15
11-Jun-15
9-Jun-15
7-Jun-15
5-Jun-15
6.3
3-Jun-15
06-Jul-15
29-Jun-15
22-Jun-15
15-Jun-15
08-Jun-15
01-Jun-15
25-May-15
18-May-15
11-May-15
04-May-15
1.5
1-Jun-15
2.1
Joint efforts to avert a hard landing in stock market China’s unprecedented measures to support equity market 27 Jun First double cut by PBoC since 2008 to support market sentiment 30 Jun The Ministry of Human Resources and Social Security published draft to revamp the pension fund system to allow maximum 30% of fund to be invested in stock market. 01 Jul
• Both Shanghai and Shenzhen stock exchanges announced to lower securities transaction fees. • Meanwhile, CSRC relaxed margin trading rules to allow brokers to roll over margin trading contracts with clients as well as cancelling rules on forced liquidation due to lack of collateral. • CSRC also widened funding channels for brokers via issuance of short term corporate bonds.
03 Jul
CSRC increased the registered capital for China Securities Financial Corporation (CSF) to CNY100 billion from CNY24 billion.
04 Jul
• 21 top brokerage firms announced to jointly invest at least CNY120 billion, accounting for about 15% of their net assets, in blue-chip stocks. Meanwhile, prop trading desk of those brokerage firms will not reduce their long position, until the Shanghai index returns back to 4500. • IPOs are suspended and all applications for 10 IPOs on 3 Jul will be withdrawn. 7 Source: BBG, CEIC, OCBC
Joint efforts to avert a hard landing in stock market China’s unprecedented measures to support equity market 05 Jul
• China’s Central Huijin, a subsidiary of CIC, confirmed that it has has bought the ETFs in the secondary market and will continue to do so. • The CSF said it will gain access to PBoC’s liquidity support.
08 Jul
• CSRC said CSF will start to buy small capped stocks in addition to blue chips. Meanwhile, it will also increase margin requirement for short index future position to 30%. • China insurance regulator will allow insurance companies to invest up to 40% in equity assets from 30% previously. • SASAC issued statement to encourage SOEs not to reduce their shares and report the share buyback position on the daily basis. • PBoC openly declared its support to market stability and confirm its liquidity support to CSF. • CSF announced to give CNY260bn credit line to 21 brokers to buy stocks after receiving liquidity support from PBoC. Meanwhile, it also invested CNY200bn in funds managed by five asset managers. • CSRC issued statement to ban large shareholders (5% above) from selling companies’ equity. • Ministry of Finance issued the statement to support market stability. 8 Source: BBG, CEIC, OCBC
Joint efforts to avert a hard landing in stock market China’s unprecedented measures to support equity market 09 Jul
• PBoC said it has provided liquidity support to CSF via relending. Meanwhile, it also approved the CSF to raise money in the interbank bond market via short term bill. • CSF issued first CNY80 billion financial bill in the interbank market. • CBRC issued the statement to support market stability. The CBRC will allow banks to roll over matured share pledge financing. Meanwhile, it will also support banks to renegotiate with wealth management product investors to readjust the stop loss clause. In addition, it also encouraged banks to provide financing services to companies buying back their shares. (Re-leverage?) To be continued
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We believe the joint efforts from CSRC, CIRC, PBoC, SASAC, MOF and CBRC on 08-09 July are likely to ease liquidity pressure and contain the contagion effect.
9 Source: BBG, CEIC, OCBC
The liquidity crisis may be over
2400
5,500
2200
5,000
2000
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4,500
1600
4,000
1400 3,500
1200
Outstanding of margin trading
6-Jul-15
22-Jun-15
8-Jun-15
25-May-15
11-May-15
27-Apr-15
13-Apr-15
30-Mar-15
16-Mar-15
2-Mar-15
16-Feb-15
2-Feb-15
3,000 19-Jan-15
1000 5-Jan-15
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Instead of buying blue-chips to artificially support index, China has started to provide liquidity to small and medium-capped stocks to revive market confidence, although it may create concern about the moral hazard. The unwinding of margin trading has accelerated for the past few days. There might be the room for further unwinding. Nevertheless, we may be in the last stage of unwinding. Once margin trading account stabilizes, the panic selling is likely to end.
CNYbn
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As of 8 July, total outstanding of exchange margin trading has been reduced to CNY1.46 trillion from the peak of CNY2.26 trillion on 18 June, close to margin trading level of CNY1.3 trillion in March when Shanghai index first broke 3500.
CSI300 Index
10 Source: BBG, CEIC, OCBC
Limited impact on real economy for now
5.0% 4.5%
4.0% 3.5%
3.0% 2.5%
Equity financing as % of total social financing
11 Source: BBG, CEIC, OCBC
2014
2013
2012
2011
2010
2009
2008
2007
2006
2.0% 2005
We see limited impact of negative wealth effect on consumption given equity investment only accounts for about 15%-20% of household financial assets and less than 10% after taking property into account. Meanwhile, given equity financing remains a small part of total social financing, the disruption to economic activity is limited. We see no urgency to change our GDP forecast for now.
2004
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2003
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We believe the current equity market rout is unlikely to lead to a financial crisis as current measures are expected to contain the contagion risk, despite banks are more exposed to equity market than ever. The direct impact on GDP can be assessed from following three perspectives including 1) contribution of financial service to GDP, 2) negative wealth effect on consumption and 3) disruption of equity financing to economic activity.
2002
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Treasury Market Research & Strategy
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