China Signals Implicit Support for Collateralized Securities Loans

Several months before the COVID-19 virus began to cripple world financial markets, the Securities Association of China announced plans that effectively legitimized the collateralized securities stock loan industry.

Near the beginning of 2019, several analysts that watch the Chinese securities markets concluded that approximately ten percent of the total market capitalization for companies whose stock comprised mainland-treaded A shares had been pledged as collateral for loans. The aggregate value of those shares at the time was 4 trillion yuan (roughly US$560 billion). The analysts expressed concerns that a bear market would result in substantial sales of the pledged shares, leading to further decreases in stock prices on the Chinese exchanges.

To prevent a greater market meltdown, the Securities Association of China publicized the formation of a 100 billion yuan (US$14 billion) asset management plan that was sponsored by a group of eleven securities firms. Few details were disseminated regarding the disbursement of these funds, but the impetus of the plan was to help private businesses that were experiencing financing problems.

Collateralized securities lenders have experienced tremendous growth in the Asian markets, and particularly in China, since 2008. Businesses and individuals have turned to stock loans to unlock the cash value that is tied up in their equity holdings. They have then used that cash for corporate reinvestment, seed financing for new ventures, and personal high-end purchases including real estate and other investment properties.

With stock loan financing, companies and individuals pledge their equity as collateral for loans. Lenders generally have a right to sell the pledged collateral if stock prices fall below certain thresholds. Sales of large amounts of pledged stock could expose the markets to substantial drops in share prices.

Chinese regulators have a history of intervening in markets to support share prices. The 2018 asset management plan could easily be dismissed as yet another in a string of those interventions. The regulators, however, have not taken any substantial steps to shut down the collateralized securities loan market. In part, that market developed to fill a gap between Chinese banks that concentrated their loan activities on state-owned enterprises and private businesses that turn to loosely-regulated shadow banks for financing. Thus, stock loans are a valuable financing alternative for small and mid-size Chinese businesses that have much of their value locked into their tradeable shares.

We cannot yet determine the near or long-term consequences of the COVID-19 virus on the Chinese or world economies. Private Chinese businesses create up to eighty percent of all jobs in China, and it is unlikely that China will allow such a large component of Chinese industrial society to fold up and disappear. The willingness of Chinese regulators to support the efforts of securities firms to prop up the markets and to take no material action against entities that source and originate stock loans speaks well of the prospects for collateralized securities loans in China. Chinese nationals and businesses can feel confident in participating in stock loan transactions with no risks that those transactions will be terminated by Chinese oversight of the securities markets.