Official data shows the surge has been accelerated by cheap credit, with the outstanding value of margin finance hitting a record 2 trillion yuan on Tuesday.

On Thursday morning at least three Chinese brokerages, including Guosen Securities Co, Southwest Securities Co and Changjiang Securities Co said they would tighten margin requirements.

"The brokerages are front running what the regulator wants to do," said Bernard Aw, an analyst at ING Markets in Singapore.

Haitong Securities and GF Securities had made similar moves earlier in the week.

"This is no longer an individual case, but an industry-wide campaign," said Zhang Chen, analyst at Shanghai-based hedge fund Hongyi Investment. "Clearly, they got guidance from regulators, and this shows a change of government's attitude toward the margin trading business."

LIQUIDITY DRAIN PLAYS ON NERVES

Key mainland sub indexes including property, energy and financial services plunged more sharply, with both energy and property slumping over 7 per cent.

Shares in several Chinese brokers fell by between 6-8 per cent.


Tian Weidong, analyst at Kaiyuan Securities in Xi'an, said that the sharp drop in financials was partly due to news that Central Huijin Holdings, an asset management company controlled by Beijing, had reduced its holdings in major state-owned banks China Construction Bank and ICBC, both of which are index heavyweights.

The news was published on Wednesday by the Hong Kong Stock Exchange in a daily disclosure report.

But he added that many investors were already looking for a reason to sell, and the changes to margin financing sparked the stampede.

"Many investors have become very cautious and are looking for a reason to take the profits they have already earned," he said.

The central bank's move to mop up excess liquidity in the interbank market was a contributory factor in the sell off.

While there was no information on how much money was drained, and money traders warned the adjustment could be minor, any suggestion of a squeeze was seen as negative for stocks.

Analysts warned of the risk of volatility intensifying.

"If the stock market suddenly reverses and investors default on their margin debts, the contagion effect will be much greater than in previous cycles, since the banking system is now more exposed to the brokerage industry," wrote Chen Long of Gavekal Dragonomics in a research note.

Reuters