Hong Kong's Billion-Dollar Plunges Show Share Pledge Danger

(Bloomberg) -- Hong Kong’s share pledge problem is raising its head once again.

Jiayuan International Group Ltd. sank as much as 89 percent on Thursday on what turned out to be a margin call on stock used as collateral by its chairman. The sudden plunge, the biggest decline in the world this year of a company worth more than $1 billion, was the latest example of a Hong Kong-listed business losing almost all its value in a matter of minutes and then revealing that an insider had pledged a substantial amount of their shares for loans.

It’s an unfortunately common peril for investors in the city, with Jiayuan following China Huishan Dairy Holdings Co., Digital Hollywood Interactive Ltd. and a host of other businesses in recent years. To reduce the risk to shareholders, authorities need to find the right balance between providing more information and protecting executives’ privacy, said Gary Cheung, chairman of the Hong Kong Securities Association.

“The more transparent the major shareholders are, the better for public decision-making,” he said.

Hong Kong exchange rules say a controlling shareholder can borrow against stock and not disclose as long as it’s for personal finance reasons rather than loans, guarantees or other forms of support for the company. Using shares as collateral for loans has emerged as a popular funding tool in recent years, especially for smaller companies that often have few alternative assets to pledge.

Jiayuan’s stock shed $3.4 billion in minutes on Jan. 17 on no news, and the company said in a filing that day -- signed by Chairman Shum Tin Ching -- that it didn’t know of any reason for the plunge. On Wednesday morning, Jiayuan said that a company owned by Shum dumped 93.6 million shares. The sale was forced by brokerages due to the “unusual and rapid downwards movements in the trading price,” and Jiayuan has asked for more information on how the stake has been used as collateral, according to the statement.

After Jiayuan denied any knowledge of reasons for the Jan. 17 crash, Shum should expect a call from the regulators, Hong Kong small-cap investor and corporate governance advocate David Webb said on Twitter.

Such selling can have an outsized effect because of low trading volume in many of Hong Kong’s small and medium sized companies. In Jiayuan’s case, the Jan. 17 sales on behalf of Shum were equivalent to about 25 times the stock’s average daily volume of the previous 12 months. Had investors known that there was a danger of such rapid selling because of share pledges, they may have priced the company differently.

Jiayuan was down 23 percent Tuesday before the shares were suspended. The shares will remain halted until further notice, according to a Hong Kong exchange statement on Wednesday, which came only hours after the company said trading would resume.

A Securities and Futures Commission spokesman declined to comment on the matter. The most recent attempt by the SFC to increase share pledge disclosure was under former CEO Martin Wheatley, who left the regulator in 2011. That effort failed due to opposition from banks and brokerages.

“We are looking into” the issue of sudden share plunges, Charles Li, Hong Kong Exchanges & Clearing Ltd. chief executive officer said in an interview on the sidelines of the World Economic Forum in Davos on Tuesday. Li added that he’s in favor of letting the market deal with stock moves. “We haven’t seen a common problem that needs to be addressed.”

Part of Shum’s lost shareholding has already been restored: Jiayuan issued 50.2 million shares to his company on Monday to settle an acquisition of Shum’s stake in a property management business. That HK$689 million ($88 million) deal was announced last year, with more information being provided in a filing on Dec. 24. It was signed off by Jiayuan investors at an extraordinary meeting last week.

Read more: A timeline of Jiayuan’s week to forget

Jiayuan joins a growing list of companies that shocked the market with huge declines before declaring extensive share pledges by their leaders. Digital Hollywood’s shares fell as much as 76 percent in November, with the company later saying some shareholders had sold pledged stock to meet loan obligations.

While Huishan Dairy’s high debt load was known before its one-day 85 percent drop in March 2017, the full scale of Chairman Yang Kai’s share pledging wasn’t made public until later. In 2016, the North American ginseng industry was threatened when Hong Kong-listed Hang Fat Ginseng’s shares dived 91 percent on a single day. The founders disclosed they had pledged shares for loans.

Stocks that plunged last week with Jiayuan also sank on Tuesday, with Sunshine 100 China Holdings Ltd. falling as much as 13 percent and Rentian Technology Holdings Ltd. losing 9.1 percent. The frequency of such declines could increase this year as China’s economy slows and more company founders find themselves struggling, said Louis Wong, director of Phillip Capital Management (HK) Ltd.

“Most of the time it is caused by a liquidity crunch deepened by deteriorating company earnings,” Wong said of the plunges.

--With assistance from Jun Luo.

To contact the reporters on this story: Sofia Horta e Costa in Hong Kong at shortaecosta@bloomberg.net;Benjamin Robertson in Hong Kong at brobertson29@bloomberg.net

To contact the editors responsible for this story: Sam Mamudi at smamudi@bloomberg.net, ;Richard Frost at rfrost4@bloomberg.net, Sarah Wells

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