While we were enjoying a day off celebrating Thanksgiving, what might have gone unnoticed was the selloff in Chinese stocks. On Thursday, Chinese mainland indexes lost over 2% as the pessimism that has been plaguing Chinese bonds spilled over to stocks. The cause of this pessimism can be traced to China’s recent crackdown on shadow banking. Recently China introduced new rules covering the $15.5 trillion in asset management products sold by financial institutions.
The rules set to go into effect in June 2018 govern products that include a number of different investments issued by banks, asset managers, insurers, trusts and mutual funds that do not appear on the issuing firm’s balance sheet. These off-balance sheet investments have gained popularity with small investors in China due to the high yields and implicit government or institutional guarantees.
The proposed regulations will prohibit asset managers from guaranteeing rates of return and will require managers to set aside 10% of fees to buffer against losses. It will also cap leverage on investments to 140% of net assets for publicly offered funds and 200% for privately offered funds. In addition, the sale of some riskier investments will be prohibited to nonqualified investors. Finally, the rules would create a regulator to unify the labyrinth of regulatory bodies that now govern China’s financial sector.
Under Xi Jinping’s leadership, the communist party is trying to increase market stability by ridding itself of the numerous special purpose vehicles that bypass current lending rules and simply recycle credit by offering highly leveraged guaranteed investments. The proposed legislation is another attempt by the government to reduce the growing problem of debt in China. This year, China’s total debt to GDP surpassed 300%. To put that into perspective, since 2007, China has taken on more debt than the US, Japanese, German, and Indian commercial banking systems combined.
The end result may be a more stable China, but in the near term the increase in Chinese yields will lead to increased funding costs for Chinese companies. This increase in rates, coupled with the crackdown on speculation, introduced fear into the equity markets. Luckily for investors that fear has subsided, at least for now. After a choppy session, Chinese stocks closed little changed on Friday. Stocks around the globe seem little phased by the Thanksgiving selloff as well.
Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.
Washington Trust Bank.