Leveraged trading comes under regulator's glare

The capital market regulator in China is tightening its oversight on leveraged trading following concerns that it may trigger sharp volatility and even social instability.

The concern was reinforced by a tragic incident in Hunan province, when an investor jumped to his death after losing his entire investment of 1.7 million yuan ($280,000) through leveraged trading.

The 32-year-old investor, surnamed Hou, borrowed money four times his own investment and bet all of that (equal to 8.5 million yuan) on the stock of rail equipment giant China Railway Rolling Stock Corp Ltd, according to media reports over the weekend.

After his purchase, the stock lost more than 30 percent of its value. Hou lost all of his investment in just two days as he failed to meet the margin call of the securities brokerage and was forced to clear his entire holding.

The incident is a sharp reminder that leveraged trading is indeed a double-edged sword. While it has been fueling the stock market frenzy and helping boost the total market value to more than $10 trillion for the first time, it has also amplified the potential risks as margin traders may lose all of their investment and possibly owe money to their brokers as well.

Analysts said the impact of the incident should not be underestimated as it may "touch the nerves" of the regulator and accelerate the cleanup of illegal financing and leveraged trading.

In a revised rule published on Friday, the China Securities Regulatory Commission capped the amount of margin trading and short selling business by a securities firm at no more than four times its net capital.

The regulator also reiterated on Saturday that securities firms are banned from offering services that allow their clients to borrow money from a third-party financing company or online financing platforms to trade stocks.

"Highly leveraged trading and illegal financing have clearly drawn the attention of the market regulator, which has repeatedly warned about the potential risks. Checking securities firms' margin trading operation is now a part of the regulator's routine inspections," said Dong Dengxin, director of the finance and securities institute at Wuhan University of Science and Technology.

According regulations, margin trading with a securities firm could offer investors a maximum of three-times leverage. But an illegal online financing platform could offer leverage as high as 10 times.