Caixin
May 06, 2020 09:00 PM
FINANCE

U.S. Broker Tightens Margin Trading on Chinese Stocks After Scandals

Many brokers allow clients to borrow money to trade stocks, a facility known as margin trading.
Many brokers allow clients to borrow money to trade stocks, a facility known as margin trading.

A U.S.-based brokerage has told some customers who borrow money to bet on small listed Chinese companies to stump up more cash as insurance against a possible crash in prices in the wake of the plunge in shares of Luckin Coffee Inc. and short-seller attacks on video streaming service provider iQiyi. Inc and online educator GSX Techedu Inc.

Interactive Brokers LLC, which operates an electronic trading platform for a range of securities including stocks, bonds, and futures, told clients last week that some accounts holding concentrated positions of China-domiciled companies with a small market capitalization will be subject to higher margin requirements. The size of the increase will depend on a stress test that simulates how the value of each stock and its derivatives held in an account might change under the scenario of a $1.5 billion decrease in capitalization of any one company, according to a notice sent by the brokerage and obtained by Caixin. Accounts that can’t provide the additional funding by May 12 may be liquidated, the broker said.

Interactive Brokers’ decision to review margin requirements for clients who have a high proportion of small U.S.-listed Chinese companies in their accounts follows a recent wave of negative news that sent stock prices of some mainland-based companies crashing, leaving many investors nursing heavy losses.

Shares of Nasdaq-listed Luckin Coffee, then a fast-growing domestic challenger to market leader Starbucks Inc., plunged 76% to $6.27 on April 2 after disclosing that its 2019 sales had been inflated by some 2.2 billion yuan. The stock was suspended on April 7 at $4.39 and hasn’t traded since. On April 7, shares in iQyi briefly dropped as much as 13.4% after a short-seller report accused it of fabricating revenue and user numbers, although they later rebounded. On April 15, GSX Techedu stock fell 5% after another report claimed it had inflated its revenue.

‘Greater risk’

The U.S. Securities and Exchange Commission (SEC) last month warned of the risks of investing in emerging market stocks. “In many emerging markets, including China, there is substantially greater risk that disclosures will be incomplete or misleading and, in the event of investor harm, substantially less access to recourse, in comparison to U.S. domestic companies,” the SEC said in an April 21 statement.

Interactive Brokers denied it was targeting Chinese companies. “Margin requirements are always based on the volatility and volume of any particular stock and are subject to change,” Steve Sanders, executive vice president of marketing and product development at Interactive Brokers, told Caixin. “Interactive Brokers never discriminates against any country or region.”

Many brokers allow clients to borrow money to trade stocks, a facility known as margin trading. Clients put up a certain percentage of funds, known as the margin deposit, and the rest is lent by the broker. Trading with borrowed money can magnify profits but also amplify losses. If brokers are concerned about the potential for losing money they can demand that the client deposits a higher percentage of their own money into their account to ensure they can cover their losses.

In its notice to clients, Interactive Brokers said that only clients whose accounts fail the stress test will be subject to a higher margin requirement. They will also have to

increase their maintenance margin, the minimum amount of money that needs to be kept in the account, to 90% of the initial margin.

Despite concerns over the quality of some Chinese companies listed in the U.S., some analysts are more optimistic about prospects for the majority.

“The market capitalization of the companies that were hunted by short-sellers recently is relatively small in the context of the overall market value of U.S.-listed Chinese stocks,” said Xu Yang, a partner in Tiger Brokers Co., a Beijing-based brokerage that caters to Chinese investors wanting to invest in overseas securities. He also noted that the overall valuation of Chinese companies listed in the U.S. has not fallen significantly even in the face of the recent scandals. The Nasdaq China Golden Dragon Index, a weighted index of 66 Chinese companies listed in the U.S., currently has a price-earnings (PE) ratio of 32.4, lower than its average of 38 over the past decade, Xu said. In contrast, the most commonly used U.S. benchmark index, the S&P 500, currently has a PE ratio of just over 23.

Contact reporter Guo Yingzhe (yingzheguo@caixin.com) and editor Nerys Avery (nerysavery@caixin.com)

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