Shanghai plunged 6.5 percent from a more than seven-year high on Thursday, dragging Hong Kong with it, as traders were spooked by liquidity fears and stricter requirements on margin trading.
The steep losses in the mainland came a day after the Shanghai composite index clocked up a seventh-straight gain that saw it advance more than 15 percent.
The benchmark Shanghai Composite Index slumped 321.44 points to 4,620.27 on record turnover of 1.2 trillion yuan ($196 billion). It had surged 52.77 percent so far this year as of Wednesday, when it closed at the highest level since January 2008.
The Shenzhen Composite Index, which tracks stocks on China’s second exchange, tumbled 5.52 percent, or 161.09 points, to 2,756.93 on turnover of 1.1 trillion yuan. Shenzhen had jumped 106.19 percent so far this year as of Wednesday.
And in Hong Kong the Hang Seng Index lost 2.23 percent, or 626.90 points, to close at 27,454.31 on turnover of HK$206.05 billion (US$26.59 billion).
Analysts said mainland sentiment was hit after several securities firms raised the deposit level for margin trading -- through which investors use borrowed funds to trade stocks.
Changjiang Securities, GF Securities and Haitong Securities Co have all increased their margin requirements, or the collateral put up by an investor when borrowing, Bloomberg said.
"The whole nature of China's market, it's all on leverage, all on margin trading, so margin calls will further push the market" as retail investors are forced to put up more collateral, said Michael-Douglas Lee, a Hong Kong-based trader at SG Securities Ltd.
- Liquidity woes -
Shanghai's stock market has surged more than 120 percent in little over a year as mainland investors had borrowed cash to bet on further increases in the hope that the government will announce a series of monetary easing measures.
And since the start of April Hong Kong shares have surged as traders began flooding the city with cash after regulators eased trading rules on a stocks connect programme with the Shanghai exchange.
The selling was compounded by fears about liquidity with several new listings due that could soak up cash.
"Tighter margin lending and an upcoming big week for IPOs (initial public offerings) constrained some liquidity," Clement Cheng, a Hong Kong-based trader at RBC Investment Management, said.
A total of 23 companies will also issue new shares for investor subscription next week, including China National Nuclear Power, draining funds from the rest of the market.
"The market slump today is triggered by concerns over tight market liquidity from new share issues next week," Zheshang Securities analyst Zhang Yanbing told AFP.
"Once the upward momentum was hurt, it's quite normal to see falls this big," he said.
In Shanghai, Citic Securities tumbled 9.43 percent to 30.73 yuan, while Shenzhen-listed Shanxi Securities plunged by its 10 percent daily limit to 24.57 yuan.
Energy firms also slumped in Shanghai. PetroChina retreated 8.61 percent to 12.20 yuan and Sinopec dropped 9.38 percent to 7.34 yuan.
In Hong Kong the Hang Seng China Enterprises Index -- which covers Chinese firms listed in the city, known as H-shares -- slipped 3.5 percent.
Among H-shares, banking giant CCB sank 3.65 percent to HK$7.65, insurer Ping An lost 4.12 percent to HK$116.30 and PetroChina shed 2.71 percent to HK$9.34.
For other Hong Kong-listed firms, Hong Kong Exchange and Clearing fell 1.83 percent to HK$300.20, HSBC eased 0.94 percent to HK$73.45 and Tencent was 1.71 percent off at HK$155.20.