Chinese equities plunged the most in six years, led by brokerages, after regulatory efforts to rein in record margin lending sparked concern that speculative traders will pull back from the world’s best-performing stock market.

The Shanghai Composite Index sank 7.7 percent to 3,116.35 at the close, its steepest drop since June 2008.Citic Securities Co. (600030) and Haitong Securities Co., the nation’s two biggest listed securities firms, fell by the 10 percent daily limit after they were suspended from loaning money to new equity-trading clients and regulators said brokerages shouldn’t lend to investors with assets below 500,000 yuan. About nine stocks dropped for each that rose on the Shanghai gauge, with more than 100 companies retreating by the maximum allowed.

The penalties have raised concern that policy makers are trying to curb a surge in stock purchases using borrowed money, after outstanding margin loans surged to 1.1 trillion yuan ($177 billion) as of Jan. 16 from about 400 billion yuan at the end of June. The Shanghai Composite index (SHCOMP) jumped 67 percent in the past 12 months through last week on record volumes as individual investors piled into the market.

“Regulators are concerned that shares have run too hard, too fast,” said Hao Hong, a strategist at Bocom International Holdings Co. in Hong Kong. “They want a measured increase in the stock market. After all, margin financing is one of the reasons for people to be bullish on brokerage stocks, and these stocks have run particularly hard.”

David Fuller's view

This regulatory decision is prompted primarily by the Shanghai A-Share Index (p/e 14.91 yield 2.13% which saw an explosive advance from November 2014 to January 2015.  It is a responsible move, in my opinion, because it should prevent a big bubble from occurring.  

While brokers and leveraged traders have been targeted, if short-term selling pulls the broader Chinese markets lower over the next few weeks, I will almost certainly increase my exposure because valuations remain generally competitive, as you can see from these two other Chinese Indices: Hong Kong Hang Seng Index (p/e 10.05 yield 3.79% and Hong Kong Hang Seng China Enterprises Index (p/e 8.07 yield 3.76%).