Why China Is Worried About Forced Selling of Company Shares

(Bloomberg) -- There’s nothing like a bout of margin calls to deepen a rout. China’s epic stock crash in 2015 was compounded by individual investors borrowing money to buy shares, and then being forced by their brokerages to sell. In this year’s meltdown, the concern centers not so much on individual investors as on company insiders and major shareholders, and their practice of share pledging.

1. What is share pledging?

Offering up shares in your company as collateral for a loan. It’s become particularly popular with founders and other big shareholders in need of cash. About half of such loans are made by brokerages, with banks and trust companies also offering them.

2. How widespread is the practice?

Very. About 11 percent of China’s market capitalization, or $632 billion, has been pledged. Some 22 percent of China-listed companies had more than 30 percent of their shares pledged for loans in the first half of 2018, according to Moody’s Investors Service. The practice is common in small- and medium-sized private companies, Bloomberg Intelligence notes.

3. What’s the worry?

As share prices fall -- and the Shanghai Composite Index has dropped as much as 25 percent this year -- this triggers demands from lenders for extra collateral. If borrowers can’t meet those demands, brokerages and banks may offload the shares, dragging prices down further. The risks came to the fore in October as sharp stock declines resulted in the sale of some pledged shares.

4. How big a concern is it?

Shareholders who pledge their stakes tend to do so on a large scale, often investing the funds back into their businesses or into other illiquid assets. That can make it difficult to top up collateral when shares fall, especially for founders who have most of their wealth tied up in their companies. There are also regulatory restrictions on large shareholders and management selling stakes. At the same time, gaining access to financing has grown increasingly tough as China cracks down on unofficial lending, or shadow banking. In the second half of 2018, more than 1 trillion yuan ($144 billion) of share-pledged loans are due, Moody’s estimates, citing financial data company Wind.

5. What has the government done?

As the stock rout worsened in October, the authorities announced a slew of measures. Local governments and the stock exchanges in Shenzhen and Shanghai were enlisted, while insurance companies were given the green light to introduce products designed to reduce the risks from share pledging. The central bank called for private equity funds to support companies with funding difficulties, and brokerages agreed to provide $3 billion to help firms with share pledging problems. President Xi Jinping vowed “unwavering” support for the country’s private sector.

6. How bad might this get?

The collective efforts of the authorities will help moderate the risks of stock-pledge loans, Goldman Sachs Group Inc. analysts wrote in October. Credit Suisse Group AG said the problem was under control, citing local government support and requirements by regulators to avoid forced selling. It also noted that the liquidation of pledged shares was rare.

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