(Bloomberg) -- China stock traders are unwinding their margin debt rapidly, underscoring how a prolonged selloff may be leading to some forced share liquidation. 

The outstanding amount of margin debt balance in mainland bourses fell by 2% on Friday to 1.46 trillion yuan ($203 billion), its biggest decline since June 2018. That reverses the upward trajectory of margin trades that started in August when policies to boost markets were introduced.

The CSI 300 Index fell as much as 3.4% in afternoon trading on Friday in a volatile session before promptly rebounding, narrowing losses to 1.2%. Shares continued to slide on Monday despite authorities’ pledge to stabilize markets.

Haitong Securities estimated that the outstanding amount of margin trades as of Thursday accounted for 4.7% of the market’s total free-float, compared with 13% in June 2015 at the peak of the equity bubble. While that percentage is significantly lower, “there could still be a risk of a negative feedback loop should stocks fall at a rapid pace and lead to forced liquidations,” analysts including Zheng Zixun wrote. 

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Investors are also growing concerned over a higher risk of forced liquidation faced by shareholders as the value of their collateral sinks. The amount of shares pledged as of last week stood at around 1.58 trillion yuan, of which about 20% have fallen below levels that require a top up in collateral, Haitong analysts estimated.

The additional value of assets needed to prevent forced liquidation was around 78 billion yuan, they said. 

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The accelerated drop in China stocks this year may be due to the increased amount of innovative products in recent years, including snowball derivative and quant products, according to Cinda Securities analysts including Fan Jituo.

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“If history is any guide, the factors behind liquidity risks mostly arise from financial products that have just experienced rapid growth in the past years, as investors lack the full awareness of their risk-reward profile,” he said. While margin trades and share pledges may also exacerbate liquidity risks, their impact is much smaller after the volatility in 2015, he added.

--With assistance from Mengchen Lu.

(Updates from fifth paragraph.)

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