Shorting China

Chinese signal a commitment to short-selling.


With stock prices plummeting and financial institutions under pressure around the world, regulators in free-market bastions like the U.S. and the U.K. haven’t hesitated to impose temporary bans on short-selling stocks. So it is striking that Chinese authorities, in the midst of the market turmoil, have decided to allow a few select brokerages to begin shorting stocks and trading on margin.

Foreign bankers have been advocating such measures for some time and regard this step as an encouraging sign that Beijing remains committed to liberalizing its financial markets. “The new trading mechanism will fundamentally change the one-sided nature of the A-share market, allowing investors to profit from falling as well as rising markets” says Jing Ulrich, chairman of China equities at J.P. Morgan in Hong Kong. “Investors will be able to utilize more-sophisticated trading strategies, moving beyond simple buy-and-hold. The introduction of these new financial instruments, and attendant higher turnover, is also good news for domestic brokers.”

The China Securities Regulatory Commission announced its decision on the new trading rules early last month. Officials haven’t said why they decided to act now, but bankers and analysts say the authorities are responding to long-standing demands from market participants. The new trading freedoms will also be under heavy restrictions, at least initially, which should enable the government to prevent any destabilizing effect on the market.

Chinese stocks have been among the worst-hit by the financial crisis over the past year; the benchmark CSI 300 index stood at 1,627.76 early this month, down 72.4 percent from its October 2007 peak.

The regulator hasn’t finalized details of the new measures, but sources familiar with the CSRC say the agency is likely to allow up to eight firms — including Citic Securities Co., Haitong Securities Co., Guotai Junan Securities Co. and Everbright Securities Co. — to start short-selling and margin trading as part of a pilot program. The program will initially cover shares of only a select number of subsidiaries of state-owned enterprises. The CSRC has set a margin requirement of 50 percent of the purchase price of eligible securities and 50 percent of proceeds of short sales.

As part of the experiment, the regulator will establish a government-run prime brokerage in the coming months to handle all margin trades and short sales, according to analysts. This prime broker will be the final arbiter of whether a trade can go through and is intended to prevent turbulence in the market, analysts say.

The initiative comes at a time when market participants are already anticipating an expansion of China’s futures markets. The country has three futures exchanges: one in Shanghai, which trades futures on metals, fuel oil and gold prices, and two others, in Dalian and Zhengzhou, which trade agricultural futures. Market participants expect the authorities to permit the introduction of the first financial futures, beginning with futures on the CSI 300, sometime in 2009. The Shanghai Futures Exchange has been conducting mock trading in index futures for the past year in preparation for the move.

Volume on the three futures exchanges has risen by 40 percent, on average, in the first ten months of this year, encouraging the authorities to proceed with further financial liberalization, says Hu Biliang, a senior economist at the Chinese Academy of Social Sciences, a Beijing-based government think tank. “Futures are an important step in determining appropriate market pricing,” he says. “It’s a critical step in China’s reforms to becoming a true market economy.”

Foreign banks have been getting ready to take advantage of any market openings. J.P. Morgan bought a 49 percent stake in Zhongshan Futures Co. for an undisclosed sum at the end of 2007 and is helping the southern China broker upgrade its information technology and risk control systems. Paris-based Newedge Group, a joint venture between Société Générale and Calyon Financial, bought a 42 percent stake in Citic Futures Brokerage Co., like Citic Securities a subsidiary of Citic Group, in January for an undisclosed price. “As a global futures broker, it was a strategic decision that we should be part of this market,” says Pierre Gay, Newedge’s Asia-Pacific CEO. “China is going to be a big market for our customers, both inside and outside China.”