Ann Rutledge was in Hong Kong when Mao died, got in on the ground floor of economic reforms and helped set up the modern risk system for the then-colony’s futures exchange before starting R&R Consulting, which focuses on asset-backed securities (ABS)—the same financial tools widely blamed for the global financial crisis of 2008.

By now one might expect China’s financial markets to have long since stopped surprising her. When Rutledge applied for a grant with the SWIFT Institute to study China’s asset-backed securities market, she said, “I assumed the Chinese market would look similar to the US market, but with Chinese-flavored assets… but I figured wrong.”

What she discovered instead was a burgeoning sector bisected by dueling regulators and beset by legal vagaries—but one that could potentially do for China what it did for the United States: Free up otherwise inaccessible liquidity to make the country’s debt market far more dynamic, opening new sources of funding for the smaller companies while also diversifying investment opportunities for the country’s banks and other financial institutions. All, ideally, without culminating in a meltdown.

The market for ABS in China has grown more rapidly than ever this year thanks to a new issuance system, and further healthy growth could also help pull a substantial sum out of the country’s notoriously opaque shadow banking sector and put it back on banks’ books. Kingsley Ong, a partner at law firm Eversheds International who was asked in 2007 to help draft China’s asset-backed security laws, said only half-jokingly that potential for securitization in China was “quite unlimited”.

But for now, a lack of industry experience and widespread failure to disclose vital information on the nuts and bolts of the products on offer in this emerging market have raised questions about its ultimate impact on the broader economy. Even Rutledge acknowledged there was a real risk.

“I believe China has no choice but to do ABS, and moreover I think they have some safeguards that we [in the US] don’t have,” she said. “But they also have a very long learning curve, and a lot can happen between now and then.”

Death and resurrection

China’s first real securitization market took shape in April of 2005 when the People’s Bank of China and the China Banking Regulatory Commission established a pilot market and regulations. Those were suspended in 2009 following revelations about the role of American mortgage-backed securities in what was by then a global financial crisis—a move for which few fault Beijing.

“While I am sometimes a critic, I will say I can understand China saying, ‘Hey, we better figure out this product and this market before we allow it to go full bore in ours,'” said Christopher Balding, a professor of economics at Peking University.

Once the dust had settled policymakers looked again to securitization to diversify China’s capital market structure, and in May of 2012 regulators fully lifted a ban on issuance—though they outlawed the structures, known as re-securitizations and synthetics, that were behind the crisis in the US. They also forbade any further issuance of products backed by non-performing loans.

Since the thaw, issuance of ABS in China has shot up dramatically: In 2014 China overtook South Korea to become the largest securitization market in Asia, and this year issuance had passed RMB269 billion (US$42.14 billion) as of the end of October, according to China Central Depository & Clearing and Shanghai Clearing House.

Eddie Hu, a partner at the Shanghai office of consultancy King & Wood Mallesons who has advised banks, auto finance companies and financial firms on asset-backed securitizations, chalked this year’s rapid issuance up to an easing of regulations. Before November of 2014, firms had to get case-by-case approval from the authorities; now they can sell freely once they’ve registered with regulators.

“The administrative process has been simplified, incentivizing those who originate and issue to do more securitization,” Hu said.

Yet for all that growth ABS remains a practical pipsqueak compared to bank lending or the broader bond market in China, with the latter valued at RMB35.89 trillion (about US$4.24 trillion) in 2014, according to Goldman Sachs (pdf). The question of what’s holding mainland securitization back requires a closer look at what exactly it entails.

Beastly complexity

Balding attributed ABS’s relatively minuscule market size in part to two main factors: A preference among Chinese investors for less complex financial products and a lack of understanding of what exactly ABS are. In the case of the latter they are not alone, as the complexity of securitization is among the many attributes that help make the sector seem impenetrable to outsiders—while also making it incredibly versatile.

An asset-backed security essentially takes contractual future cash flows or expected operating cash flows and converts them into immediately fungible funds by borrowing against those flows and the assets that generate them. For example, as has been done with certain expressways in China, the company that owns a toll road can use that road as collateral in order to get financing from investors now based on the income it has yet to make from tolls paid by drivers who will use said road.

To actually come up with the money, the company can set up a financing vehicle that offers interest-bearing securities to investors based on those expected cash flows from future toll payments. Once investor financing is secured, the vehicle will actually buy the toll road from the company—so the company gets money now, and the financial instrument begins directing money from toll payments directly to the investors holding the securities until the promised payouts are paid off in full.

If the cash flows from the toll road dry up, the investors can take the road and sell it off as compensation. And because the company doesn’t actually own the road anymore, it can’t stop the issuer from transferring ownership to those investors.

A financial institution typically helps set up the issuer – known as a special purpose vehicle (SPV) – that issues securities to investors, often in different batches that are classified based on their level of risk, which is tied to priority of repayment. The risk level of each batch is certified by one or more ratings agencies.

The credit rating for such securities can be higher than that of the company from which they originated because the risk being evaluated is that of the cash flows themselves. “So your company might not be triple-A, but you can still issue bonds that are triple-A,” Eversheds’ Ong said. “That is a phenomenal advantage.”

Thus, securitization can enable a company to raise funds more easily than might be otherwise possible through a loan based on its balance sheet. It also creates a new class of investment with risk portioned out to suit the tastes of investors, which can range from more cautious pension funds to less risk-averse private hedge funds.

But Beijing has added another wrinkle to the proceedings by separating ABS into two categories, administered by two different regulators.

Showcase shortcomings

The first, most-favored variety falls under the Credit Assets Securitization Scheme (CASS), trades on China’s interbank market and is regulat
ed by the China Banking Regulatory Commission. Here, assets originate with banks, trust companies, lenders and auto finance firms, securities for which are issued by trust companies on their behalf to be snapped up by institutional investors.

CASS is the bigger and more liquid ABS market: According to the working paper Rutledge authored for the SWIFT Institute, 62% of all 206 Chinese securitizations were CASS, accounting for 82.2% of total principal issuance of RMB605 billion (US$94.52 billion) as of June 25.

Of the 127 CASS deals analyzed in the working paper, nearly three quarters were collateralized loan obligations (CLOs)—securities backed by a pool of debt, typically sourced from small- and medium-sized enterprises. The next-largest cohort, auto loans, stood at just over 10%.

Yet while similar CLO offerings are priced higher than general-purpose corporate bonds in US and UK markets, Balding noted that’s not the case in China.

“What that seems to indicate is that either the companies aren’t selling the [securitized] bonds properly… or the investors don’t believe what the companies are saying they don’t believe that the securitized bond is giving them anything more tangible in return,” he said.

This apparent undervaluation of the interbank market’s most popular ABS offering may lie in the shortage of two key assets: Information and experience. Rutledge said that about 90% of the deals in China’s showcase CASS market lacked vital information demanded by international standards.

“The only deals that I can get what we call servicer data – what we call underlying performance data – on are coming out of deals that foreign manufacturers are doing, specifically the auto manufacturers,” she said.

Disclosures from automakers like Nissan, BMW and Volkswagen is standardized, allowing ABS investors to determine how many loans are delinquent, how many have defaulted and the likelihood of being repaid in full on time.

Indeed, Hu said the performance record of auto loans’ underlying asset pools was “quite good compared with other corporate loans because they’re very diversified.” That’s the kind of performance record that attracts international investors, he said.

For the remaining 90% or so of the CASS market that isn’t backed by auto loans such data isn’t made public, though it is collected by the China Central Depository & Clearing, the official clearing company for the interbank market.

Trust issues

Outside of China’s interbank market ABS growth is being held back by the uncertain legal status of the framework currently available for use by non-financial institutions in securitizing assets.

The question is that of the vehicle created to issue securities to investors on behalf of a company and which takes on ownership of the assets. While financial institutions use special-purpose trusts, which are well-established in PRC law, those aren’t an option outside of the inter-bank market.

Under the current setup, known as the Asset Backed Specific Plan (ABSP), non-financial firms have to use contracts to transfer ownership of assets. The resulting ABS cannot be traded on the interbank market and are regulated by the China Securities Regulatory Commission, but can be offered to retail investors and even listed on the mainland stock exchanges. But regulatory backing for such deals only amounts to administrative rules, which can be overruled by a host of higher regulations.

As laid out in a recent study (pdf) of China’s securitization law published in the Capital Markets Law Journal and co-authored by Ong, such rules “may have different levels of enforcement in different parts of China, and may be subject to policy changes over time, or even competing political interests.”

Ong said the guidelines were of real use and worked under most circumstances. But if a securitization backed by a company’s most precious assets were to default and investors came calling, a judge might have to decide between honoring the contract and following other, higher-level state laws that hold workers’ rights in higher regard.

“Would the judge say that the securitization investors – who are the big boys, the professional investors – should get the money? Or will they say no no no, the money should be returned to the workers so they can feed their families and what have you?” Ong said. “I think under those circumstances it is less clear.”

This fundamental uncertainty helps explain why as of late June principal issuance in the ABSP market had grown only 3.4 times that seen prior to the 2008 market hiatus, while average deal size had fallen to RMB3.87 billion (US$607.7 million), just 56% of its pre-freeze level.

By comparison, ABS trading on China’s interbank market has expanded to colossal proportions: Principal issuance of CASS had grown to RMB497.6 billion (US$78.09 billion), eight times what it was in 2008, while average deal size grew just over 1% to RMB3.29 billion.

Untapped potential

Eddie Hu at King & Wood Mallesons said that the clearer picture for investors of underlying assets and risk pointed to brighter prospects going forward of ABS issued by financial institutions. But even here he was conservative, citing recent cuts by the central bank to China’s benchmark lending rate as easing any pressure mainland banks were under to find more funding.

“I don’t think there will be a leaping increase in issuance numbers or size, but I think the number of issuances and issuance size will increase gradually in the coming years,” Hu said, pointing in particular to local commercial banks at the city level and below as likely to try their hand at ABS.

That is looking more likely in light of recent regulatory easing: In June, Reuters reported that the China Banking Regulatory Commission had granted provincial branches permission to green-light new issuance for cities’ commercial banks for their ABS plans—though big banks apparently still needed issuance approval from the commission’s headquarters in Beijing.

Yet even those approved by the banking regulator remain opaque by the basest standards of international ABS investing, Rutledge said, adding that local knowledge of the routines industry analysts typically use to rate the different batches produced by securitizations was sketchy in China at best.

“People are doing deals and the deals seem to work, but one of the reasons the deals are working is because the high-performing collateral is what’s being securitized,” said Rutledge. That could change.

Moreover, cordoning off financial institutions’ ABS trading to the interbank market also means they ostensibly aren’t helping disperse risk that is concentrated in the banking sector, instead serving largely to help banks ease pressure on their balance sheets.

But Rutledge cautioned against taking for granted that such restrictions were always observed in practice. Without more performance data transparency, she said, it will remain difficult to judge whether cash flows are as healthy as claimed and going where they’re supposed to.

“When people want to see a market grow they’ll say anything, and they’ll turn a blind eye to things that are obviously problematic,” Rutledge said. “You can’t put a fence up and expect it to contain water. Water flows. Money flows.” ♦

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Author: Hudson Lockett (@KangHexin)

The size of the yuan’s initial drop this week seems to have overshadowed its cause, perhaps understandably: The currency’s trading-band fall of nearly 2% against the US dollar on Tuesday hit many unsuspecting investors, analysts and journalists square on the jaw like a hard left hook.

But heading into the third day of the new and largely unproven currency regime that made the drop possible, it is worth scrutinizing what exactly the new scheme entails and why the old one was dropped, as well as the implications for systemic risk in China as it embarks on what could prove to be a significant step in a long-promised campaign of financial reform. 

On the mainland and increasingly abroad, everything from gold to property to equities to cabbage is bought with the yuan. Put simply, there is no nexus so central to China as its currency. And now the central bank has cranked the coin of the realm’s volatility up to unprecedented levels.

Fresh ink, new rules

Thus far, the People’s Bank of China (PBOC) has played by the new foreign exchange rules it laid out Tuesday morning: Previously the central bank would, without regard for market sentiment, set a midpoint for the yuan’s dollar exchange rate from which the currency could float up or down by a maximum of 2%. The new mechanism has the PBOC still setting the midpoint, but is supposedly based on the market movements of the previous day.

That has remained technically true, though on late Wednesday afternoon news broke that the PBOC had ordered state-owned banks to sell dollars in the last 15 minutes of trading. Thus, after nearing its bottom limit of 2% devaluation, the yuan’s dollar value swooped back up by about 1% to set a less drastic midpoint for the start of Thursday trading.

Chen Long, China economist at research firm Gavekal Dragonomics, said he suspected this policy combination could continue: The bank can allow the yuan’s fixing price to follow from the spot market closing price, protecting its credibility; but it can also intervene in the spot market as needed to prevent the currency from falling by 2% every day.

“Therefore the PBOC avoids a massive depreciation that can potentially harm financial stability, and soon we will see real money starting to buy RMB again,” Chen said. 

Financial fallout 

The new foreign exchange regime – assuming it holds through the rest of this week – could be the most substantial move so far under President Xi Jinping’s administration to follow through on promises to give the market a greater role in China’s economy. Just not too great.

“It appears that in the first two days of this [scheme] that what they’re trying to do is let the market play a greater role in determining the exchange rate, but not let it play too big a role,” said Christopher Balding, associate professor at the HSBC School of Business at Peking University.

Balding suggested the downward pressure on the yuan’s value was largely a happy coincidence, and was skeptical that any resulting impact on China’s exports could be extricated from regular business cycle changes. 

Speaking shortly before the PBOC intervened in the spot market, he said the bank would likely move to halt downward movement it considered too sudden. “My sense is they’re content to let the RMB glide down a little bit,” Balding said. If that means increased capital outflows from China’s financial sector, so be it. Balding also suggested keeping an eye trained on interest rates: “If maintaining the [exchange rate] peg is less of an issue, that does give the PBOC the freedom to lower interest rates and potentially help out Chinese businesses.”

There could be enormous strain on public and private actors with dollar-denominated debt such as property developers and some local governments, but Balding said that this was unlikely to influence the central bank’s decision making, due to its relatively small portion of total debt.

Straightening priorities

That is not to say China’s financial system is heading into the new exchange regime risk-free. While Beijing’s crackdown on short-selling and other bullish activity in the mainland stock market has ratcheted down volatility in recent weeks, other, larger systemic issues have remained largely unaddressed.

The World Bank outlined many of these in June in a special section of its latest China Economic Update titled “Reform Priorities in China’s Financial Sector”. The critical section got a good deal of press, then was taken offline; the update was later reposted without it. The bank claimed the section hadn’t been properly reviewed before being published—despite having been based on a previous report the bank had co-authored with the State Council’s Development Research Center, according to a footnote from the original report .

Vetted or not, the section contains a trenchant breakdown of systemic dysfunction, the presence of which has become more glaring in recent years as transition away from export dependency got underway. In it, the bank calls for substantial revision to the state’s three roles in China’s finance sector: Promoter, owner, and regulator.

In condensed form: The section’s authors argue that the regulatory role of the government has long been subordinated to its role as promoter of economic growth, resulting in a credit-dependent economy that does a sloppy job of distributing credit where it is needed—per its own demands in its role as owner of finance-related companies.

That ownership, which extends beyond state-owned enterprises to the private companies the government can effectively control, is hard to overstate. The World Bank’s estimates in the deleted section, based on data from 2012, indicate that the state effectively owns 94.5% of bank assets, 79.8% of the insurance sector’s premiums, 88.1% of trust assets and 79.9% of security companies’ total assets. The bank thus calls for a smaller state ownership role—though not for the government to completely relinquish control.

The analysis is not solely critical: The bank commends the establishment of a deposit insurance system in May of this year, as well as regulatory and legal reforms to the shadow banking system to close loopholes and create a more level playing field with other nonbank financial institutions, like trusts and insurers.

But in addition to a smaller ownership role, the bank also calls on the state to implement interest rate liberalization that would allow the market to determine the interest gained by China’s consumers on their bank deposits. Part and parcel to this central plank of reform, according to the bank’s analysis, are supportive monetary and exchange-rate policies.

Warping perceptions

Whatever its intentions, the PBOC’s actions have garnered cautious praise from t
he one international institution whose approval Beijing may desire more than any other: The International Monetary Fund. The fund called the new foreign exchange mechanism “a welcome step as it should allow market forces to have a greater role in determining the exchange rate.”

That is important because The IMF can grant China the financial prestige so clearly desired by the current administration, specifically in the form of the yuan’s inclusion in the basket of currencies granted “special drawing rights” (SDR). That would confer the status of a global reserve currency on the yuan.

“The symbolic value is huge,” said Chen at Gavekal. “They’ll have made the RMB one of the five most important currencies in the world.”

Just about a week ago the IMF suggested that the yuan still had a ways to go before it could be included in the SDR currency basket. Eswar Prasad, former country head for the fund in China, told The Financial Times the report indicated “that the decision about the renminbi’s inclusion in the basket hinges on financial market development, further opening of the capital account, and greater exchange rate flexibility.”

But as with any fall in the value of the yuan, this week’s sparked outcry from American politicians claiming currency manipulation, despite even the IMF assertion earlier this year that the currency was actually no longer undervalued.

New York Senator Chuck Schumer – who has previously called on the IMF to ban China from inclusion in the SDR basket – told The New York Times that for years, “China has rigged the rules and played games with its currency, leaving American workers out to dry. Rather than changing their ways, the Chinese government seems to be doubling down.” 

Populist politics aside, much of the blame for misperceptions about the causes of Tuesday’s fall and the new exchange regime lies with the PBOC itself, which claimed on Tuesday that the 1.9% devaluation which had occurred under the new setup was a “one-time correction to close the gap between the reference rate and the market rate”.

When Wednesday morning’s mid-point actually reflected Tuesday’s closing rate and overnight shifts in foreign exchange markets, the bank was simply following through on a promise to implement its new rules rather than engaging in purposeful devaluation. Based on its intervention late Wednesday, the central bank may not have expected another such tumble after Tuesday’s initial fall.

In practice, though, the new scheme has – last least in its first two days – been followed to the letter of the central bank’s law. Balding suggested that this may have been prompted in part by China’s growing capital account deficit, though he was careful to add that “I don’t think that’s going to cause a payments crisis.” Chen, at Gavekal Dragonomics, said the motivations for the change could be numerous, but suggested the most direct issue was SDR inclusion. But beyond symbolic value, he said the status’s practical benefit to China was “not that much, to be honest.”

For now, at least, everything remains up in the air: Dangerous and demanding all attention, like cutlery just thrust skyward. The PBOC sets the yuan’s midpoint at 9:15 am on Thursday, and will hold a press conference to explain its new policy at 10:30 am. What it does and says will move markets, though where the yuan will end the day against the dollar is impossible to say. That may be why Chen kept mum when asked how low China’s currency might go.

“I think the market knows that better than any researcher,” he said. ♦

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Author: Hudson Lockett (@KangHexin)

Two years ago Song Jingqiu earned an 11% return on his investment on one of China’s largest P2P lending platforms, Renrendai. For the 27-year-old investment manager at China Guangfa Bank, the take was almost double the 5.6% percent annual return he was making at the time through traditional, offline wealth-management products.

“Such high yield makes P2P look attractive to Chinese investors,” Song said. And that’s the problem.

Peer-to-peer lending platforms – websites that match those seeking to invest extra funds directly with those in need of credit to start a business or make a major purchase – have exploded in China. Between January and June this year the number of mainland P2P websites increased from 1,627 to 2,028, according to data from Chinese P2P lending portal Wangdaizhijia.

Most offer loans worth less than RMB100,000 (US$16,110) to individuals and small businesses. But as more platforms have crowded in, loan volume has grown, too. As of June, the total trading volume on P2P platforms topped RMB6.6 billion (US$1.063 billion), up 8% from May. But the same lack of industry-specific regulation and low cost of setting up a P2P platform that can attain an average 15% gross margin ratio have fostered substantial risks for everyone involved in the industry, whether they are aware of it or not.

“The low market entry barriers [have] attracted many entrepreneurs who lack the adequate risk management capabilities to run a lending business,” said Allen Su, a P2P industry headhunter. “The essence of P2P business is still a financial platform operating financial services. It should be regulated.”

Garden varieties

There is no single business model for China’s blossoming P2P lending sector. PPDai, one of China’s fastest growing P2P firms which launched in 2007, adopted the more traditional P2P model of a matchmaker and information provider.

The site doesn’t get involved in any loan contracts and serves only as a platform to facilitate lending by providing necessary information such as borrowers’ credit scores, for which it charges a fee.  Borrowers list their loan requirements on the site and individual lenders decide whether to lend to them—simple enough. Often, upfront collateral isn’t even required.

But retail investors like Song aren’t the only ones flocking to P2P for higher investment returns than banks can offer. Cash-strapped individuals and small businesses pile in in pursuit of lower-priced credit.

China’s banks primarily focus on making loans to state-owned enterprises and local governments that are seen as being guaranteed by the central government, leaving a huge funding gap for individuals and small business owners that need financing. That gap has become an open door for China’s underground lenders, who charge annual rates as high as 60%. But with an average rate of return of about 17.4% for borrowers, according to an estimate from online private lending information site Rong360, P2P lending sites quickly became an attractive alternative. PPDai had completed RMB 4.8 hundred million (US$77 million) in the first quarter of 2015, a 247% increase year-on-year, according to figures published by Wangdaizhijia in May.

The surge in new business has fostered new business models as platforms evolved beyond simply matching investors and borrowers. Renrendai seeks investors online but now also vets borrowers and reviews loan projects through conventional channels offline in order to better mitigate investor risk.

But many such sites slice, dice and package the loans they facilitate and can list details such as the term and interest rate being offered, profiting primarily off of interest spreads—the difference between the average lending rate and the average borrowing rate. Lenders can still decide which of these loans they want to make. But as Song put it, he and they “have little idea what we are buying.”

Easy money, risky business

“The interest rate on P2P is high relative to that of traditional banks because of the risk of default,” Song said. “Unlike a bank loan that requires collateral, lots of P2P loans were unsecured, issued based solely on the borrower’s credit history.”

Lack of an established and transparent credit certification system makes the online lending industry particularly risky in China. Wang Kun, founder and CEO of a P2P platform Duanrong.com, estimated in June that 8% of China’s P2P loans have become non-performing assets.

Moreover, the loose regulatory environment has led to non-transparent business practices that involve high risk and are often quasi-legal (if that).

On paper, the China Banking Regulatory Commission currently bans P2P firms from raising funds. In practice, however, borrowers are under no obligation to disclose their revenue, expenses or funds allocation. “At these kinds of small, irregular companies, it’s possible to build up capital pools, mismatch assets and liabilities and to misappropriate funds,” said one corporate lawyer surnamed Sun at a major US law firm’s mainland branch, who requested that his full name not be disclosed.

This means many P2P firms, supposedly required to act solely information brokers, are charging for services that only licensed banks or lending companies can provide.

“It’s really dangerous, due to the lack of regulation. If a P2P firm runs into trouble, it will shut down and run away with lenders’ money,” said Su, the industry head hunter. News of such businesses closing down and declaring bankruptcy has been become more frequent, with figures published by Wangdaizhijia showing that as of July 28, the number of failed P2P platforms in China had reached a total of 864 with registered capital of at least RMB21 billion (US$3.381 billion), since more than 100 platforms have no available data.

Off-market, on-market

Since the government has by and large allowed the industry to grow unchecked, the products offered on these platforms can change rapidly, said Gao Yating, a P2P industry analyst with the People’s Bank of China School of Finance at Tsinghua University. As China’s stock market began taking off in July of last year, some P2P platforms turned to the business of shadow margin lending.

This new sector is known as “changwai peizi” in Mandarin: “off-market fund-matching” that allows stock investors to use borrowed cash from lending companies to make bets in the stock market and, more importantly, avoid any of the restrictions faced by formal margin trading, such as a cap on margin-financing size and capital requirements for brokerages that offer margin lending.

During the start of the stock market run-up in 2014, P2P platforms like Miniu98.com, Touna.cn and 91wangcai.com began offering leverage of up to five and sometimes even ten times the value of an investor’s portfolio in some cases—far higher than sanctioned margin lending.  Local media reports have detailed how clients trade in the equity market via sub-trading accounts connected to brokerages that do not always require them to disclose their true identities, creating a potentially massive grey market.

“Potentially,” in that the true total of lending through P2P off-market fund matching remains unknown. As a result, so do its effects on the stock market proper, though they were large enough to prompt authoritie
s to investigate the cloud-based P2P platform HOMS, run by Hundsun, a financial information firm controlled by Alibaba founder Jack Ma.

Borrowing unbound

Since the China Securities Regulatory Commission launched a crackdown on off-market fund matching to stem the stock selloff that began in mid-June and which was reportedly worsened by margin trading, several Chinese P2P operators, including Miniu98.com, have announced they will exit the margin-lending business. On July 18 Beijing unveiled guidelines for the overcrowded sector that call for closer government supervision and require agencies to coordinate regulatory responses to avoid another pell-mell flurry of policy measures like that seen during the market’s first collapse.

According to Gao, the guidelines are unlikely to force consolidation of P2P operators since they only restate previously announced plans to regulate the sector, which still lacks any concrete regulations. If the industry does run into serious difficulties, there are fears that the damage would not be isolated to the P2P sector thanks to its adaptive nature and relative ease of use—and abuse.

Earlier this year, local media reported several cases in which many small-sized real estate developers had established P2P businesses to raise funds for their own construction projects. When the developers couldn’t meet repayment demands because of a slowing property market, it triggered a wave of defaults, resulting in losses for P2P investors.

Contagion risk can also grow if troubled property developers pass on these risks to the end-property buyers. In some cases property developers sell and require down payments from buyers before they start construction. If these developers go bankrupt before completion, the buyers bear the entirety of the loss, as happened with cases in Beijing and Jinan highlighted by state media.

These substantial risks may have already had an adverse effect on the market as a whole, dampening investor enthusiasm. “Many of these (P2P) investment are very high risk,” said Song, who withdrew his money after the wealth management product he’d bought on Renrendai had matured.

Still longing for high returns but afraid of shouldering too much risk, Song has turned to Lufax.com, a P2P platform backed by China’s second largest insurer, Ping An Insurance Group. Lufax Chairman Greg Gibb said his firm uses Ping An’s balance sheet to guarantee all of its loans in a Q&A with Lend Academy. Regulatory dearth aside, that promise seems to have been enough to assuage Song, who has invested a few hundred thousand yuan in a three-year P2P wealth management product offered by Ping An. This one has an 8% rate of return. ♦

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Author: Xin Yuan (@yyyuanxin)

Editor: Hudson Lockett (@KangHexin)

It is just after 9 am on Monday, June 29 on the campus of Fudan University in northeastern Shanghai. Stray cats stalk across well-manicured lawns near a reflecting pool; passing showers fall from mottled gray clouds; a pigeon coos from its perch atop a towering statue of Mao Zedong. And Wan Long has forgotten his umbrella.

The electrical engineering senior from Hubei province jogs over to meet a journalist and soon they arrive together at a 15th floor cafe overlooking the center of campus. Wan is a little wet, but otherwise very lucky—and he knows it. He cashed out of China’s stock market before it tanked last week, walking away with a total profit of RMB222,000 (US$35,700).

He does not yet realize he will get back into the market on Tuesday, or how fast and far share prices will fall on Thursday. And Friday.

In the aftermath of Chinese stock prices’ free-fall last week, state media blamed malicious traders for “shorting” the country’s stock market, suggesting that there had been some kind of concerted – possibly foreign – effort to destroy mainland shares’ world-beating rally. “Shorting” a stock essentially means making a bet that its price will fall instead of rise during a certain period of time. But in mainland China, traders can’t short specific stocks or sectors. They can only short broad swathes of the market. So long as the rally’s continuation seemed certain, anyone would be a fool to bet that Chinese stocks – “A-shares” – wouldn’t rise.

While blaming the shorting of Chinese stocks for the Thursday-Friday selloff may seem absurd on its face, it might also be true—but not because of any ill intent on the part of those who bet against the rally. Rather, by wagering that Chinese stock prices were more likely to fall than rise, these pessimistic traders may have sent a signal to others watching the market saying that they no longer believed the rally could continue. When enough of those orders came in, and enough of those watching got the signal, minor doubts could snowball into an avalanche of fear and panic. And because the entire rally had been driven by the belief that share prices would keep rising, when that confidence faltered far enough, prices had to collapse.

From the most casual traders to the most sophisticated, there is little attempt to deny the role of word of mouth in driving stock prices’ movements in China. Indeed, the ability to take advantage of untrained traders’ impulsiveness depends entirely on how early one gets word that this or that firm will do or announce something important which could trigger a buying spree (or selloff). It is really quite simple to buy low and sell high in China if one learns the right information before it becomes widely known, even if that information is nothing more than “sell now.”

That is why social connections make such a huge difference when investing in firms listed publicly in mainland China. And it is why a 21-year-old electrical engineering major can plausibly attempt to out-trade a full-time investor and stock-trading veteran. This is their story, told through the first three morning and last three afternoon sessions of the Shanghai Composite Index’s most turbulent five days in decades.

•

Morning

The First Day

(Session opens: 4276)

Wan Long orders a watermelon smoothie and turns back toward the journalist. He has a boyish face framed by black-rimmed rectangular glasses and a lip dusted with whiskers. One long hair sprouts from beneath his chin—left untrimmed, for good luck.

But at 21 years old, Wan has worked hard to get here. He cleaned up on the national college entrance exam in Hubei province, and having just finished his senior year finals is glad for the chance to take it easy. Being out of the stock market is relaxing, and not just because he sidestepped financial catastrophe: “Having money in the stock market, it really affected me,” Wan says.

He’d been driven to distraction during class, amid lab experiments, and even on the job during his internship with the commerce department of the US Consulate. Sometimes it was hard to focus on fostering trade between China and the state of Illinois with his parents’ life savings on the line.

Wan had begun with his own savings of RMB20,000 and, after making a decent return, had been asked by his parents to manage about RMB2 million on their behalf. He lost about 10% of that sum early on, but quickly recovered it as the rally proper kicked off. He says he’d nearly doubled his money—“but then the profit disappeared.”

On the advice of an older student Wan walked away from the market in the middle of last week with a total of RMB2.2 million, well up from his starting point but down from a peak of RMB2.8 million. He says he plans to put the proceeds toward paying tuition at the economics school of Vanderbilt University.

Wan says he relied chiefly on two sources of information when investing: His own research and, perhaps more vitally, news and advice from his friends and fellow-members of Fudan University’s many WeChat stock trading circles.

“I think one of the reasons my parents didn’t earn money [on the stock market] is because they didn’t communicate with others,” Wan says walking back to his dormitory in the southern half of campus. Wan had made sure to stay informed through ten-plus student groups on the social networking service, one cluster of many led by students from every department. It was one such leader who told Wan to get out last week.

In his dorm’s activity room – still festooned with Christmas decorations and a small plastic tree – Wan looks over his old portfolio. “Heavens,” he says on booting up his dilapidated smartphone, still missing its back cover. Both of his biggest plays are down around 10%, about as far as A-shares can fall before a firm’s stocks are frozen for the day. He wishes he’d sold sooner, but is glad he experienced both a rise and fall while working the market.

Some of his friends still have skin in the game and keep sending panicked messages out over WeChat. As the morning session nears its end Wan heads to the cafeteria. Sipping on a cup of tofu juice he watches as the Shanghai composite index closes the morning at around 4035 points, down 3.57%.

“Terrifying,” he notes in a quiet voice, eyes glued to the screen.

(Day closes: 4053)

•

Morning

The Second Day

(Session opens: 3998)

Fatty, it turns out, is not great around strangers.

Chen Pan, an investor at Great Wall Securities, apologizes for the great white fuzzball of a cat, which wrestles free of his grip and rushes across the hallway into the opposite bedroom.

“Please—please have a seat,” he says, motioning to the bed.

Birds chirp outside Chen’s seventh-floor window as he begins his workday trading from home. “I don’t expect things to change too much today,” he says, pointing to his desktop monitor and laptop, both displaying stock charts and trading figures.

Chen is 29 years old, has been trading for eight years, and lives wit
h his parents—an existence neither embarrassing nor uncommon for someone living in a city where property prices can rank among the most expensive in the world. His room is small but neat; he is round-faced, bespectacled and soft-spoken. 

While he majored in e-commerce management at Shanghai Normal University, Chen got into finance because he found it fascinating: “Trading stocks isn’t just something simple,” he says. He’d only just begun as an investor when the China’s last big stock market crash began in 2007. Watching the market fall down around him has stuck with Chen.

“That left a deep impression on me,” he says. Looking around he saw that investors lacked expertise. Rather than do their due diligence they largely asked for tips from friends and family and followed whatever advice they got. “The disposition to follow is extraordinarily intense,” Chen says. He holds a dim view of the latest rally as well.

“The government wanted the current rally to help digest dead or illiquid assets,” he says. “You can see whenever the stock market went up, there was basically a big reduction of state-owned assets, or state-owned shares.” This is why he expects the government to step in and save the market should the rout continue.

“Suppose you are a first-time investor. When you find out that you can’t make money in the market, you’ll never come back again after you leave,” Chen says. “The government is afraid that once the market collapses, lots of retail investors will leave and not come back, even if the market goes up in the future.”

Chen is largely unfazed at 10:11 am when the index falls to 3903 points. He continues explaining that while mainland individual investors are immature, regulations are often harmful as well. Among a variety of issues, he singles out limitations on short selling as among the worst offenders.

Short selling a stock or index can serve to hedge risk by providing a means to profit even when the entire market is experiencing a downturn. But doing so requires traders to have at least RMB500,000 in their accounts. He says the requirement is unfair to people that invest in the stock market who aren’t rich because it leaves those who often drive mainland stock rallies more exposed than their wealthier counterparts.

This and other unique features mean that “the difference between the domestic and foreign markets is truly huge,” Chen says. They simply don’t operate in the same way or follow the same rules. Still, he figures surmounting such difficulties to make successful investments has its benefits: “If you can trade here, you can trade anywhere.”

Research can be key, and Chen says he spends 6-7 hours a day doing his homework. Economics and finance books line his wall, and for the journalist’s benefit he pulls out some of the financial textbooks he began studying on his own a few years back. His favorite book, though, is a biography of Jesse Lauriston Livermore, famous for shorting the US stock market just before the Great Depression struck in 1929.

Still, he adds, “sometimes it doesn’t matter how much information you have.” Retail investors often seek out “inside information,” but he says that such claims are most often bunk—either originating online from a publicly accessible news story or having simply been made up. Sometimes personal connections can prove most key to finding out vital news ahead of time, but even that can’t guarantee investment success.

He and other traders at institutional investment firms usually keep an eye out for new policy drives – like the new One Belt, One Road infrastructure initiative – and reform announcements concerning restructuring of state-owned assets, as with recent mergers of state nuclear and rail companies. Before last week’s fall his portfolio was up 150%. (Now it’s only up 120%.) Most of his friends are up by more than 100% as well. None think the market has peaked, either.

“I’m a very, very, very, very conservative trader,” he notes, though he later confesses, “I’m hoping for miracle this afternoon.” He laughs. “There could be one—and then the next morning there will be a huge selloff.” This morning’s session is not quite so cruel, closing up slightly at 4052 points.

(Day closes: 4277)

 •

Morning

The Third Day

(Session opens: 4182)

Mr. Wang waits a little while before introducing himself.

On the second floor of the Nanjing Securities Trading Hall in central Shanghai, Ms. Song, a retiree investor, explains how she made so much money from China’s stock market in the late 90s that in 2000 she was able to afford a home not too far from where the journalist and his colleague are now standing. Now she just invests casually, and only in the morning session.

Most afternoons she goes home and reads a book instead of staying to trade. After all, it’s only a short walk. Seeing that matter settled, Mr. Wang inserts himself into the conversation.

“Most people invest based on their feelings,” says the short, spritely gentleman of 65 years. A native of Shanghai, he bears an uncanny resemblance to the comedian and director Mel Brooks. He always carries a thermos with him, atop which he holds a tiny glass tea cup steady with the palm of one hand. He swings his other about with wild abandon whenever he speaks. Which he will do, at great length, in about an hour.

First there is Mr. Xu to speak with.

Today is the first day of Mr. Xu’s retirement, whether he likes it or not. Mr. Xu worked as a mechanic at a government-owned factory in town until 2003, when the government allowed it and countless other small state-owned enterprises (SOEs) to go under—though the largest would eventually list on the Shanghai Stock Exchange. That may be one reason why he says he’s not wild about the idea of state firms granting employees stock options.

Having been let go, Mr. Xu was forced to seek work as a janitor for a movie theater until he reached retirement age, and his hands are calloused and raw from the work. Held in one of them is a smart phone used to track his investments.

He says they amount to the entirety of his life savings: RMB30,000. It was RMB50,000 before last week’s dip. He’s still investing based on family and friends’ advice. “They speak and I buy,” he says. It is 10:32 am and the market is riding high at 4297 points.

In the stairwell outside the noisome second-floor trading hall Mr. Wang gives his own life story, at once similar and entirely different. He was ordered out of Shanghai in 1970 to work as a steel mill manager in the inland province of Jiangxi.

“This was back when Chairman Mao was alive,” he says, “and we thought we might be going to war with the Soviet Union!” But battle was not in the cards for Mr. Wang, who would spend three full decades in the city of Xinyu. (“Very beautiful.”) He found a wife, had a child, and then came home to Shanghai – and his parents – 15 years ago when he was let go during the massive layoffs that accompanied SOE reform in the late 90s.

Fresh from the bosom of the state he went full-time with what was once only a side gig: Stock trading. Having traded since the early 90s, Mr. Wang says he’s learned China’s market was and remains neither regulated nor predictable.

“You can’t control this market,” he says with another grand wave. He says only short-term investors can make money
on mainland markets thanks to sub-par regulations that make longer-term investment “like riding an elevator”—all ups and downs.

Indeed, Mr. Wang says he lives just an elevator ride from where he stands, in a second home above what is now the stock hall that he bought with his investment earnings after the steel mill let him go. He heads to grab a bite as the index closes at 4260 points.

•

Lunch

The Third Day

After the morning session ends Mr. Wang heads up to his room some floors above for a modest lunch. He makes himself cold noodles and rice porridge – same as always, he says – then comes back down for the afternoon session. The journalist neglects to ask whether he took the elevator or the stairs.

•

Afternoon

The Third Day

(Session opens: 4249)

Back downstairs, Mr. Wang reveals that everyone in his family is trading, including his daughter. This time around he has invested RMB10,000. At the peak his stocks were worth RMB17,000 before they fell. Still, at RMB13,000 now he’s doing alright. Patrons at the hall can also go over to the counter to get a loan of RMB10,000 should they need some extra funds for a bit of margin trading.

While the market is flawed, he says, it is still a better place to make money for many ordinary people than most other alternatives in China. But he admits it would be faster to trade up in his home compared to the clunky consoles here on the second floor. The connection is much faster.

“But Chinese people like to gather,” Mr. Wang says. And besides, at the trading hall they can turn to someone for help when a computer proves uncooperative. He has clearly tried every method of investing, and holds a special distaste for swapping shares via smartphone. It’s not the technology. It’s the connection.

“3G, 4G? bah! Too slow,” he says. The connection can get pretty spotty, and during peak hours heavy traffic can bog down wireless networks even more, especially during the trading day. That is still probably better than the stock hall’s main LED-lit boards, which cycle through a range of stocks in six-second shifts. Unlike in the western world, red (color of China and the party) indicates that share prices have gone up, while green means they’ve fallen.

As Mr. Wang explains to a novice what kind of information the monitor of a trading console can display, most of the numbers on the screen begin to switch from red to green. He has noticed, and predicts the index might go as low as 3800 tomorrow. Mr. Wang is unruffled. Ms. Song has gone home to read. Mr. Xu is nowhere to be found.

(Day closes: 4052)

 •

Afternoon

The Fourth Day

(Session opens: 4249)

It is 1 pm and Fatty won’t come out from under Chen Pan’s desk. He drags her out and she quickly frees herself and bolts for the door. He notes the policy announcements from last evening appear to have had little effect on trading for the day so far: Things seem to have gotten even more volatile.

Online there isn’t much in the way of serious explanation as to why, though some have decided to blame malevolent foreign investors short-selling mainland stocks. Chen says for microeconomic developments in China he usually goes to EastMoney.com and Zf826.com. The former provides some relatively useful news; information from the latter isn’t very dependable, but there is plenty of it. For the macro picture he typically goes to the Chinese-language version of The Wall Street Journal.

None seem to fully explain the drop’s intensity: By 1:46 pm the index is down at about 3920 points, and in addition to red and green figures, trading volume figures are starting to show up in purple instead of the regular yellow.

Chen explains that purple is reserved for particularly large trades shortly before a few more purple figures start popping up on screen. And a few more. More. He wonders out loud how the government might slow the rout—halting listings or… more purple numbers. “Terrifying,” he says.

At 2:07 pm the index is down to 3853 points. Chen sighs and fiddles nervously with the cover of his iPad. At 2:12 pm his father brings in a plate of watermelon slices. At 2:14 pm the index has fallen to 3796 points. Sparrows tweet outside the bedroom window as Chen watches in silence. At times purple seems close to covering the screen. He suspects many of these are automated trades, carried out by computers.

Even if they are, nobody has any idea what has traders so spooked—not Chen, not any of his friends, and least of all the journalist. At 2:56 pm the index has swooped back up to 3909, but Chen’s mind is made up: He’ll wait for tomorrow’s opening trades. “If there’s a bad open tomorrow…”

(Day closes: 3912)

•

Afternoon

The Fifth Day

(Session opens: 3785)

Throngs of unseen cicadas chorus in the trees of Fudan University. Flower sellers gather at strategic intersections, eyes peeled for any proud parents passing by. Capped and gowned graduate students make their way south toward the campus’s stadium to get their diplomas, but Wan Long already got his this morning.

He still needs to take a few pictures, though.

As he and the journalist make their way toward the center of campus, Wan reveals that he got back into the market on Tuesday. The journalist’s arched eyebrows prompt quick clarification: Wan only put in 5% of his money, and got out on Wednesday morning before the fall that afternoon on the advice of another expert.

They reach the center of campus to meet up with Wan’s friends from their branch of a multinational university organization that, in its Fudan incarnation, sends students to inland provinces to teach teachers how to use key tech and programs and speak Mandarin. They also record audiobooks for blind children. On the shelves of their recording room where Wan’s friends are waiting sit volumes including Charlotte’s Web and The Little Prince.

The group sets off for the main campus plaza for photos with Wan intermittently checking the plummeting index on his phone, which is quickly running out of power. Many of his friends have refused to cash out even after losing all their profits and then some.

“Most of them are at a maybe 30 or 40% loss,” he says. “They say it’s hard for them to look at the screen.”

Rumors are flying through his WeChat circles claiming that the government has ordered state-run securities firms to plough money into the market to stave off financial crisis. For now the most immediate crisis is how the group will pose together in their farewell pictures. The entire process takes half an hour before they
break up… to take pictures in groups of two or three for another ten minutes.

Finally Wan breaks away and makes a beeline for the recording room. He can’t check the index—his phone’s battery is dead. With ten minutes left he plugs it in only to find there’s no WiFi signal in the room. At eight minutes to go he turns on the computer to find it can’t connect to the Internet. He runs outside to ask the hall’s custodian to open another room.

She shuffles, slowly, toward the relevant doorway. And slo-o-owly turns the key.

Finally he’s inside, plugged in and catches a signal just in time to see the index tick down its final few notches, from -4.44% to -5.77%. It has dropped about 225 points in the space of one day. For a moment the only sound in the room is the whine of a mosquito as it flies by the journalist’s ear. Wan begins to worry about whether a financial crisis could devalue the renminbi, undermining his earnings and making tuition in the US more expensive. He pulls up WeChat, where dark humor is being used to cope with harsh reality.

“The weekend is here!” notes one friend in a tone of playful despair. “At last: It can’t fall any further.”

(Day closes: 3686)

♦

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Author: Hudson Lockett (@KangHexin)

Research: Yuan Xin (@yyyuanxin)

A lone console had opened up in the far corner of Shanghai’s Nanjing Securities trading hall, but not for long. Clad in a pea-soup green sweater with hair a short-cut hurricane of maroon, an elderly woman shuffled swiftly over to the console’s number pad and began clacking out commands. After a beat she squinted and adjusted her rose-motif bifocals before throwing her hands up in the air. 

“Aiyah!” 

She shuffled off dejected, but had soon shaken off the loss like a bad round of mahjong. As with that classic game of quick wit and luck, it is easy to see why she and other individual investors have piled their spare cash and sometimes their savings into mainland China’s so-called A-share market: Profit. Only 14 of the 2,547 firms listed on the Shanghai and Shenzhen stock exchanges saw share prices fall in course of this year’s first four months, according to figures from financial data company Hithink RoyalFlush cited by the newspaper Beijing Youth Daily.

That said company is itself listed in Shenzhen (and that its chairman became a billionaire thanks to the current bull run) detracts none at all from the rally’s reality, even if unease has mounted among international observers, particularly after the Shanghai Composite Index dropped 6.5% on Thursday. It may fall further on Friday. But expectations of a full-on collapse because share prices are totally divorced from financial fundamentals may be misplaced, at least for now.

Indeed, that yawning gap between valuation and actual value is what made the rally possible in the first place. As far as Shanghai and Shenzhen are concerned, market fundamentals couldn’t be less important thanks in large part to the investment approach adopted by the droves of individual investors driving the current rally. These so-called retail traders, often stereotyped as inexperienced gamblers and hailing from every age bracket, aren’t concerned with traditional investment metrics like price-to-earnings ratios.

Instead they’re keeping an eye on policy announcements and banking on further easing measures like bank reserve requirement cuts and stimulus rollouts commonly viewed as good for listed companies, regardless of whether they help China’s flagging economy. In fact, the worse the economy gets, the more government support expands, and China’s individual investors have thus far responded by plowing yet more money into stocks, driving prices even higher.

“The problem at the moment is that it’s very difficult to interpret what’s happening in the markets because they’re being driven not by fundamentals, but by investor sentiment,” said Julian Evans-Pritchard, a China economist at markets research firm Capital Economics. “There’s always some sentiment, but other markets are more grounded, whereas China has become less attached to economic fundamentals—especially in the last six months.”

Market rules

There may not be an agreed-upon definition for what constitutes an economic bubble, but general consensus has settled on a list of phenomena that any observer of Chinese equities over the past year would find all-too familiar: Large surges in IPOs and newly opened trading accounts; irrational upswings in stock optimism based on only minor growth; speculative stocks greatly outpacing valuation of dividend-paying stocks; and a general drop in financial expertise among those engaging in trading.

But investment in the so-called A-shares traded at the Shanghai and Shenzhen stock exchanges is not directed by the same economic rule book that serves as the basis for other markets’ operations.

“China is more and more driven by views on what policy makers are thinking in terms of supporting the market or not,” Evans-Pritchard said. “You can see this in terms of how often [prices] swing on editorials published in state media, because those editorials often swing [between caution and encouragement] as well, and markets react accordingly.”

One elderly gentleman at the Nanjing Securities trading hall was more critical: “Retail investors will go whichever way the government’s red flag points,” he volunteered, before declining to give even his surname. He added that he sometimes couldn’t figure out why certain stocks had shot up until he’d seen the corresponding policy announcement on TV. The mix of state-owned and commercial newspapers pinned to cork boards on both floors of the hall drove his point home. One headline proclaimed: “Shanghai Composite Index above 4,500 again; ChiNext unceasingly hits new heights”.

These and other features of Chinese securities markets can be traced back to impetus behind the establishment of China’s bourses in the early 90s, when top leaders were looking for a way to turn state-owned firms into economic powerhouses. They first consolidated many smaller companies into a few major ones worthy of listing in Hong Kong and New York, after which these newly minted corporate giants returned home for a victory lap listing on the mainland. However they remained, by requirement, state-owned, with only a portion of shares put up for grabs. In China stocks can freely change hands, but ownership of a listed firm cannot without regulators’ approval.

In lieu of possible ownership rights shareholders would – at least in other markets – still have one reason to keep stocks that aren’t rising: Dividends. These regular payouts skimmed off the top of a company’s profits typically give investors a reason to hold on to stocks through short-term price volatility. But in China cash disbursement is the exception to the rule.

According to a 2013 survey by Palisades Hudson Financial Group, 60% of companies listed in mainland China didn’t pay cash dividends at all. That may be in part because disbursements from Shenzhen and Shanghai-listed stocks are subject to taxes, whereas capital gains made from rising stock prices are not. To combat this obvious crossing of purposes the Shanghai Stock Exchange issued the “Guidelines on Distribution of Cash Dividends” in early 2013 ostensibly mandating all companies to make a 30% payout of profit—but a loophole allowing firms to explain away their failure to do so by giving “alternative uses” of their profits suggests this move was mostly symbolic.

Heng Chen, a professor of economics at Hong Kong University, said they probably wouldn’t help anyways. “Volatility means all the attention is on short-term gains,” Heng said.The current rally is driven by investors seeking ever-escalating share prices that put what pitiable dividends that are offered on the mainland to shame. So long as prices rise at a sufficiently speedy clip within a certain period of time, there will be little incentive for listed firms to start such payouts.

Retail only

The other major difference between mainland markets and the rest of the world is investor makeup: Where giant investment firms dominate the board in London and New York, individual investors make up the majority of traders in Shenzhen and Shanghai and account for far and away more of the daily trading volume than local brokers. Their numbers have only increased since July, when the Shanghai-Hong Kong Stock Connect was first announced.

The speed with which still more retail investors have invested for the first time appeared to take a dramatic leap in late April, when Bloomberg reported that 2.8 million rookie stock pickers had joined the rally in the two weeks ending April 27, five times the average of the past year. The figure was based on the number of new accounts registered, which for the past 17 years had been limited to one per person. But on Monday, April 13 – the start of the two-week period in question – the China Securities Depository and Clearing Corporation lifted the ban on multiple accounts, and that individual investors would be allowed to have as many as 20 open at the same time.

That further muddies the waters for anyone hoping to suss out why certain stocks seem to suddenly do so well, an issue already obscured by investors whose rationale for a given investment can be tenuous at best. A group of middle-aged women clustered in a corner of the Nanjing Securities trading hall said they had no strategy whatsoever—just buying what they heard other people had bought. Asked for his own strategy, one of the men in a cramped alcove of consoles opposite the women snorted, threw back his head and yelled his answer for the benefit of the room: “Strategy? There’s no strategy! We’re all doing this for kicks!”

Whatever the reason, the upswing in investment is undeniable. “Previously people perceived that Chinese households had huge savings for every kind of purpose, but recently research has shown this sort of rebalancing from savings to the stock market,” said Heng, who has done extensive research into Chinese household savings rates. “Some households have even pulled money out of insurance to put into the market.”

That has been compounded by an increase in borrowing money to double-down on investments by individual investors, a practice known as margin lending. Given the potential knock-on effects likely to reverberate throughout the economy should the market tank, regulators have been cracking down on the practice in waves, with a January move to punish overenthusiastic brokers producing the largest valley prior to this week in the Shanghai Composite Index’s mountainous ascent, though that only lasted for about a day.

The effects of the crackdowns have likewise proved fleeting, Pritchard-Evans said, with figures from both mainland bourses showing no significant deleveraging had taken place as of the end of April. That may not spell doom for most individual investors, however, as Heng noted that that regulators in China required traders to have at least a half-million RMB before they could trade on margin. That suggests that while the economic ramifications of a crash would be felt economy-wide, many retail investors would only lose as much as they put in (although there are signs that, too, may be changing).

Yet the age of those trading may be as important as the amount they invest. Older generations in China may have savings to throw around, but if a greater portion of young Chinese have begun trading, any losses could still be felt years down the line. Historically, at least, that has not been the case: China Securities Depository and Clearing has always provided a by-decade annual breakdown in its yearbooks. By the end of 2014, the relative size of each age bracket hadn’t changed too much from 2013 even as the absolute number of accounts increased. Account holders in their 30s and 40s made up over half of the 139.1 million traders as of December 31.

Which age groups have most bolstered the trading masses since then is less clear. Beyond anecdotal snatches in the local press, the onl
y official statistics released don’t quite match the standard brackets. In late April, China Securities Regulatory Commission spokesperson Deng Ge said that during the first quarter of 2015, 30-40 year-olds accounted for about 32% of nearly 8 million new accounts, while those under 30 accounted for about 36%, and those over 60 made up just 5%, according to a report from the Huaxi Metropolis News.

While it appears that investors under 30 might have been rising as of the end of March, the April lifting of the ban on multiple accounts means new additions no longer represent market demographics one-to-one.

Getting schooled

Recent reports have also noted with alarm a survey showing that two thirds of the new trading accounts opened within the last year—which in total make up more than half of all active A-share accounts on the mainland—had been started by people who had not graduated high school. But Heng said it went beyond that.

“Many retail investors do not even have a middle school education,” he pointed out, shortly before cautioning against the assumption that higher education led to better investment practices. Education, Heng said, “is not a determinant for success, but correlates to things like patience,” which can be useful to traders.

For Johnson Huang, a student at a top university in Shanghai who is known among his peers for an interest in finance, that has proven to be true. Huang entered the market nine months ago to see if he could apply what he’d studied to investing in Chinese stocks, only to learn there was so much hidden information that making sound financial decisions was all but impossible.

“I discovered the stock market in China has nothing to do with finance. Many of the %K line charts are faked, and the values of different stocks are evaluated based on nothing,” Huang said. “It’s all about government policies and inside information.”

Retiree Xu Chungen could’ve told him that. Sporting a faded blue Nike cap and matching trousers, Xu said he’d caught the investing bug working at one of the first mainland companies to list back in the early 90s. Smiling at the thought of his earnings, he claimed he’d made hundreds of thousands of yuan during his trading career, and noted he still bought a copy of the newspaper Sichuan Fianance every day.

Having survived the last bubble’s popping in 2007, Xu said he had confidence that government would handle this latest rally better than it had those prior. As he spoke on the steps outside of the trading hall, investment consoles behind the hall’s glass façade sounded just-finished trades with a ceaseless staccato of scattershot pings, like sonar machines gone haywire. “There are too many individual investors in the Chinese stock market, especially those without experience who have been flooding in after they sensed an opportunity to make money,” Xu said.

The upshot is that a deteriorating economy is actually of great benefit to mainland stocks, since government support — particularly cuts to banks’ reserve requirement ratio — has thus far proven a sure-fire ticket to boosting the investor sentiment driving prices upward. This seems to have produced a vicious, virtuous cycle in which the worse the real economy becomes the better Chinese stocks perform, flying ever-higher beyond the levels at which a traditional market would price them. So far that has been a boon for Beijing.

“The government actually desperately needs a boom in the stock market,” Heng said. Indeed, on Thursday the National Bureau of statistics said in a statement on its website that equity earnings were responsible for April’s rebound in industrial profits. The ongoing rally has been incredibly profitable for the Chinese government, the ultimate owner of many listed state-owned companies; this has provided a boost for China’s leaders as they attempt to deal with serious shifts in the composition of the country’s economic drivers and shortfalls in growth expected to see further exacerbation through the year’s end.

Even should economic realities begin to worry retail investors rather than egg them on, Capital Economics’ Evans-Pritchard said that if a selloff began it might not escalate to a crash, since policymakers could still step in to prevent a sharper downturn. For now, at least, they don’t seem willing to let the market stop growing. “It’s a question of when, and we don’t think it will happen soon given the current conditions,” he said, “but it has to happen at some point.”

Until then the investors at the Nanjing Securities trading hall most likely to take a real haircut may be those who want one. By half-past ten an enterprising young man was offering day traders a trim at the top of the staircase on the second floor. One middle-aged woman clutching a dark leather purse had taken him up on it, and as the morning wore on little tufts of black began to pile at her feet. ♦

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Author & photographer: Hudson Lockett (@KangHexin)

Research: Nancy Gong, Andrew Ross