Recently, macro concerns such as the Sino-US trade tensions and the decelerating Chinese economy have been worrying the market. Another significant overhang is the situation surrounding pledged stocks in the A shares market.

Shareholders of listed companies can pledge their stocks to financial institutions such as brokerages, banks, and trusts in return for loans that are worth a percentage of the value of the pledged shares. In the past few years, more private enterprises have been engaging in this practice and the percentage of these pledged shares has been climbing for companies across the board.

The overhang of the market is that, as quite a number of stocks have dropped significantly, the market fears that it would trigger margin calls for those with pledged shares. If investors are not able to fulfill margin requirements, lenders will sell their pledged shares to close out their positions and in the process , it may cause the shares to drop further. Thus, a vicious cycle may form and cause a domino effect. Some major shareholders could end up losing control over their companies.

In recent weeks, new policies were released by regulatory authorities to address this market worry.

On October 22 , China Securities Regulatory Commission (CSRC) announced that 11 securities houses had reached a consensus to start a fund with RMB 21bn initial investment¹. Each house will separately set up their sub-funds to raise money from banks, insurance companies, state-owned enterprises and government platforms etc., forming a fund with total scale of RMB 100bn to help some listed companies tackle liquidity problems¹.

China Banking and Insurance Regulatory Commission (CBIRC) also allowed insurance asset management companies to set up special products to invest in listed companies’ securities. The investable universe includes stocks of listed companies, bonds issued by listed companies and their shareholders, non-public issuances of exchangeable bonds by shareholders of listed companies, and other assets approved by the CBIRC. Institutional investors such as insurance companies and social security funds are usually the main source of fund for special products.The first product was reportedly set up by a large state-owned insurance company on October 29 whose scale was expected to reach RMB 20bn².

Securities houses are required to obtain approvals from the CSRC before they execute forced-selling of the pledged shares. The purpose of this measure is to make sure any collateral-selling will be conducted in an orderly manner. At the same time, we think that the over-seeing of the selling activities might ensure there is minimal conflict of interest between the pledgees and the pledgers.

It is apparent that this risk in the market is well understood by the government and we believe that it has placed a high priority to contain it. Unlike the messy downward spiral that occurred in 2015 after the government cracked down on buying stocks on leverage, the situation concerning pledged stocks is much more transparent in terms of the scale and the parties involved. Hence, our base case is that the government will be able to contain the situation.

[1] Source: Xinhua net, as of Oct 2018

[2] Source: Jiemian, as of Oct 2018

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. You may lose part or all of your investment. You should not make an investment decision solely based on this information. If you have any queries, please contact your financial advisor and seek professional advice. This document is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

The growth momentum in China has shown signs of weakness as seen by recent economic data. For example, the September NBS manufacturing PMI declined to 50.8 from 51.3 in August, with major sub-indexes edging down¹.

On Oct. 7, the PBoC announced the fourth reserve requirement ratio (RRR) cut this year, cutting by 100bps which reduces the RRR for large banks to 14.5%². The amount of liquidity released from this cut will likely amount to Rmb 1.2trn². Rmb 450bn will be used to replace the Medium-term Lending Facility that is maturing in October, while the rest will be used to support liquidity, and we believe this will alleviate funding pressure from tax submission in October². We think the effect of RRR cut is limited, as evident by the slumping SHIBOR rates, indicating the unwillingness of banks to make new loans to the real economy despite sufficient liquidity.  Nonetheless, the RRR cut may help local governments sell more bonds to banks. Bond issuances are expected to peak between 3Q and 4Q which may boost total social financing and infrastructure investment in 4Q18 and next year. In addition, we believe more fiscal and monetary policies will be released in the coming months as the Minister of Finance announced that he is studying tax cuts possibilities.  Finally, while the RRR cut will add to RMB depreciation pressure, we believe the central government has placed higher priority on tackling internal challenges over external uncertainties at this juncture, and therefore should be determined to avoid high fluctuation of RMB exchange via stringent capital control for the rest of 2018.

Although we’ve shifted to a more conservative strategy in volatile markets, we stay very alert to the possibility that the tide could turn when the government initiates more aggressive measures to support the economy. The Fourth Party Plenum of the 19th Party Congress is scheduled to take place around the latter half of November. We expect the government to form internal consensus on how strong the stimulus measures should be implemented.  For instance, VAT rate cut could be an effective tool to boost consumption and GDP.  We estimate that for every 1% cut in VAT, there would be RMB520bn (0.6% GDP boost) worth of tax savings to the general public³. Additionally, for every 1% rate cut of social security contribution by corporates and/or individuals would reduce their burdens by Rmb250-300bn³. We consider various tax reductions to be much more direct and powerful tools to support the real economy than RRR cuts, and we believe that the government will implement those measures when necessary.

[1] Source: National Bureau of Statistics, as of September 2018

[2]Source: BNP Paribas, as of October 2018

[3]Source: Zeal Asset Management Limited, as of October 2018

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. You may lose part or all of your investment. You should not make an investment decision solely based on this information. If you have any queries, please contact your financial advisor and seek professional advice. This document is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.