South Korea’s stock market experienced a sharp decline this summer with retail leveraged positions being rapidly closed, further amplifying the downward trend. Now, market focus has shifted to China where the local financing scale remains at historic highs, with funds highly concentrated in popular technology stocks such as AI and semiconductors.
Analysts are warning that if tech stocks were to plummet again, China could become the next market in Asia to be on alert for.
Columnist and Founder/CEO of Emmer Capital Partners, Manishi Raychaudhuri, pointed out in an analysis article on Tuesday, September 8, that financial trading has rapidly increased in various Asian markets in recent years, with China’s relative scale particularly prominent.
As of August 31, the financing balance on the Shanghai Stock Exchange was approximately 13.4 trillion yuan (about $2 trillion), equivalent to about 2% of the total market value. In comparison, Japan and India had financing balances accounting for only around 0.45% and 0.3% of their respective market values.
Of particular concern is that China’s current financing balance is 8% higher than during the previous peak in May 2015. Following a rapid increase in leverage that year, the Shanghai Composite Index plummeted by around 48% over the following eight months.
However, Raychaudhuri also cautioned that trading rules and regulatory environment in China’s stock market today are different from 2015, and they cannot be directly compared. Nevertheless, the current scale of leverage remains a clear warning sign.
Another risk in China currently lies in the concentration of financing funds.
Raychaudhuri pointed out that Chinese investors are similar to previous South Korean retail investors, with leveraged funds primarily flowing into large electronics, semiconductor, and telecommunications companies. If popular tech stocks were to rapidly decline, forced liquidation of leveraged positions may further exacerbate the market downturn.
This summer, South Korea’s stock market demonstrated how such risks can evolve.
From June 22 to July 30, the KOSPI index plummeted by 39%. Prior to this, driven by the AI frenzy, South Korean retail investors heavily utilized brokerage loans to buy into technology stocks such as Samsung Electronics, SK Hynix, as well as more volatile single-stock leveraged ETFs, explaining why the KOSPI had surged by 116% over the past year until June 22.
However, when tech stocks tumbled in June due to concerns about the sustainability of AI capital spending, leading to valuation downgrades, the collateral value swiftly decreased. Many investors were forced to meet margin calls, some unable to add cash and had to undergo forced liquidation by brokerages, further fueling the stock price decline and creating a self-reinforcing selling cycle.
By the end of June, South Korea’s financing balance had peaked at around 38.7 trillion Korean won (about $287.5 billion), only accounting for about 0.6% of the total market value but still causing significant impact during deleveraging.
The South Korean National Assembly has now begun to investigate related policy responsibilities. The National Assembly’s Legislative Investigation Office recently included “Single Stock Leveraged ETFs” as a key agenda item for this year’s governmental oversight.
The Legislative Investigation Office stated in a report that within two months of the listing of such ETFs, the KOSPI Sidecar market stabilization mechanism (pausing relevant program trading orders for 5 minutes) was activated 23 times, with circuit breakers triggered 5 times. The “South Korean version of the VIX,” VKOSPI, soared to 97.99 on June 29.
The report recommended that the National Assembly objectively evaluate the policy effects to determine whether the original overseas investment demand has truly shifted to the domestic market or if there is additional leverage investment demand domestically while overseas investment demand remains unchanged.
China’s market currently presents not only potential risks but also some positive developments. The latest data indicates that after the tech stock slump in July, leveraged investors have begun to reduce their positions.
“South China Morning Post” reported on September 4, citing China Securities Finance data, that as of September 3, the outstanding balance of margin buying stocks (i.e., financing balance) was approximately 2.62 trillion yuan (about $390.1 billion), a 13% decrease from the historical peak of 3.01 trillion yuan set on June 25.
This data covers the Shanghai, Shenzhen, and Beijing stock markets in mainland China, different from Reuters’ cited Shanghai Stock Exchange’s 1.34 trillion yuan financing balance, but both indicate significant leveraged positions in China’s stock market at present.
The recent deleveraging began in July following the tech stock sell-off. The Sci-Tech Innovation 50 Index, mainly composed of chip stocks, plummeted by 26% that month, marking the largest monthly decline on record. By early September, the index was nearing its previous low.
Even though leveraged positions have been reduced, financing funds are still heavily concentrated in technology stocks.
The “South China Morning Post” cited statistics from East Money Information, stating that as of September 3, the financing balance of China’s leading optoelectronic company “Zhijie Xuchuang” reached 31.5 billion yuan, ranking second on the mainland China exchanges, with its competitor “New Easy Gain” at 19.2 billion yuan.
Additionally, the financing balance of AI chip design company “Cambricon Technologies” reached 17.5 billion yuan, while China’s leading DRAM company “Changxin Storage” had 11.1 billion yuan.
This indicates that after the initial round of deleveraging, popular sectors such as AI, chips, and optical communications still have significant financing exposure.
However, market participants remain more cautious about China’s leverage risks.
UBS Securities’ China stock strategist, Meng Lei, believes that resistance caused by the deleveraging in the Chinese stock market may be relatively limited. Currently, the main headwinds could stem from rising US Treasury yields and the possibility of redemptions faced by China’s mutual funds heavily invested in tech companies.
China’s regulatory authorities have tightened financing rules this year. The China Securities Regulatory Commission approved the Shanghai, Shenzhen, and Beijing stock exchanges to increase the minimum margin requirement for investor margin purchasing of securities from 80% to 100% starting January 19, aiming to moderately reduce market leverage levels.
However, these measures have not completely eliminated related risks.
South Korea’s experience this year has shown that when high leverage, concentration on popular tech stocks, and rapid market declines converge, margin calls and forced liquidations may swiftly amplify the downward trend.
While China’s current situation cannot be simply equated with South Korea’s, nor can it be deduced that a 2015-style stock market crash will recur, the high level of financing, concentration of tech stock exposure, and ongoing deleveraging process still make China one of the most closely watched risks in the Asian markets.