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By Bloomberg

China’s stocks fell for a third day, sending the benchmark index to a one-week low, amid speculation increased regulatory scrutiny of margin loans will spur some leveraged investors to reduce holdings.

Citic Securities Co. and Haitong Securities led declines for financial companies with losses of at least 2.3 percent. The securities regulator plans a new round of checks into the margin-lending businesses of brokerages, the Xinhua News Agency reported Wednesday night. Trainmaker CSR Corp. and China Railway Group Ltd. rose after the government said it will promote railway firms’ overseas investments.

“The authorities sent a signal that they don’t feel comfortable,” said Yuliang Chang, Hong Kong-based strategist at Deutsche Bank AG. The pace of growth in margin lending and umbrella trusts “is creating a systemic risk in the financial industry,” he said.

The Shanghai Composite Index dropped 1.3 percent to 3,262.31 at the close, paring this month’s gain to 0.9 percent. Regulators are increasing scrutiny on margin financing and umbrella trusts after investors ramped up bets on rallying shares through the use of leverage. Higher leverage exposes individuals to larger losses in the event of stock-market drops, which can be exaggerated as investors scramble to repay debt during a selloff.

The CSI 300 Index declined 1.2 percent. Hong Kong’s Hang Seng China Enterprises Index fell 1.9 percent, while the Hang Seng Index lost 1.1 percent. The Bloomberg China-US Equity Index retreated 1.3 percent yesterday.

Margin Debt

The Shanghai index has gained 59 percent over the past year, making it the best performer among 93 global indexes tracked by Bloomberg, on speculation the central bank will ease monetary policy to support the economy. The measure is valued at 12.2 times 12-month projected earnings, compared with 7.9 for the H-shares gauge, according to data compiled by Bloomberg.

The Shanghai gauge sank the most since 2008 on Jan. 19 after regulators suspended three of the nation’s biggest brokerages from adding new margin accounts and told securities firms to stop lending to traders with less than 500,000 yuan ($80,035). Margin debt increased to a record 775.9 billion yuan on the Shanghai exchange yesterday after a tenfold increase during the past two years.

Brokerages, insurers and some new economy stocks which have benefited from growth in margin debt are the most vulnerable, said Deutsche Bank’s Chang. Margin trading turnover represents 24.1 percent and 18.6 percent of the financials and property sectors’ total turnover respectively, according to Bocom International Holdings Co.

CSRC Probe

A gauge of financial shares in the CSI 300 dropped 1.9 percent for the biggest loss among 10 industry groups. Guoyuan Securities Co. fell 4.1 percent. Western Securities Co. slumped 3.9 percent. China Life Insurance Co. declined 2.3 percent. Industrial & Commercial Bank of China Ltd. slid 2.8 percent.

The assessments will focus on 46 remaining brokerages after an initial 45 were checked, Xinhua said in the report. The China Securities Regulatory Commission said the checks were routine and shouldn’t be over-interpreted, it said.

The CSRC’s assessments will focus on small- and medium- sized brokers, according to people who asked not to be identified as they weren’t authorized to speak publicly about the matter. Regulators will examine brokers’ internal controls and business processes, the people said.

In a margin trade, investors use their own money for just a portion of their stock purchase, borrowing the rest from a brokerage.

Umbrella Trusts

Curbing leverage “depends on how aggressive they are,” said Michael Every, head of Asia Pacific financial-markets research at Rabobank International in Hong Kong. “The issue is how tough regulators are prepared to be when the economy is already slowing.”

Some brokerages in southern China raised the threshold for new umbrella trust products, requiring at least 30 million yuan instead of 10 million yuan before, the Shanghai Securities News reported today, without citing anyone. The Securities Times reported earlier in the week that China Everbright Bank Co. will lower its leverage ratio for umbrella trusts from next week to reduce funding risks.

In umbrella trusts, private investors take up the junior tranche, while cash from trusts and banks’ wealth-management products form the senior tranches. The latter receive fixed returns while the former take the rest, so private investors are effectively borrowing from trusts and banks.

Slumping financial and property stocks foreshadow more losses for the nation’s equities market, Hao Hong, head of China research at Bocom International, wrote in a note. The Shanghai property gauge has fallen 9.3 percent this year, while the CSI 300 financial index slid 9.2 percent, the worst performers among industry groups. The CSI 300 financials and Shanghai property sub-indexes both surged 86 percent last year.

CSR added 0.9 percent and China Railway Group gained 1.2 percent. China will promote railway and nuclear power companies’ overseas investment to offer design, construction, equipment supply and operation services, according to a State Council meeting chaired by Premier Li Keqiang.