Four months after introducing margin trading and short sales to the Shanghai market, Beijing is considering a significant expansion of this trial project in a bid to spur struggling equities.
The objective is simple: liquidity. With the market losing more than a quarter of its value in the first half of the year and the economic environment still uncertain, the government needs to boost investor sentiment. Widening exposure to new products is one way of achieving this.
It also reflects Beijing’s commitment to pressing ahead with financial reforms.
Among various measures, Chinese regulators recently lowered the threshold for securities firms to join the program and are mulling plans to set up intermediary agencies to facilitate money and securities lending.
Margin trading – whereby investors borrow to fund stock purchases – and short selling – whereby investors sell borrowed securities with a view to buying them back later at a lower price – are essentially designed to allow people to profit from a declining market. However, they also tend to make equities a more complicated playground for retail investors.
In order to ensure tight regulatory oversight, participation was initially limited to six brokerages – CITIC Securities (600030.SH), Guotai Junan Securities, Haitong Securities (600837.SH), Guosen Securities, Everbright Securities (601788.SH) and GF Securities. Only 90 companies – the top 50 Shanghai-listed firms and the top 40 Shenzhen-listed firms – are approved as target stocks for the program.
These restrictions greatly dampened the influence of the pilot program – the daily value of margin trading and short selling only accounts for about 1% of the combined turnover on the Shanghai and Shenzhen stock exchanges.
In an apparent signal to expand margin trading and short selling, the China Securities Regulatory Commission in early June admitted a second batch of brokerages – China Galaxy Securities, Shenyin & Wanguo Securities, Orient Securities, China Merchants Securities and Huatai Securities.
The net capital requirement for participation has also been reduced from US$730 million) to US$440 million, potentially brining another 15 brokerages into the fold, including Essence Securities, China Securities, Ping An Securities, China International Capital Corp and Guoyuan Securities. They are expected to receive licenses in August after completing a trial trading period.
Establishing third-party companies able to borrow money or securities from large institutional investors such as insurance firms and pension funds, which can then be lent out to individual investors via brokerages should further spur liquidity. If it works smoothly, it should prove to be a handy arrangement: Investors can get the funds they need while big institutions can earn fees from lending out assets that would otherwise sit idle as part of long-term investment strategies.
Apparently it will take six months to get the intermediary business up and running. Investors shouldn’t be impatient – the delay shows that the regulators are taking seriously what will be a red letter day in the development of margin trading and short selling. Thorough research must be carried out into the sources of securities and capital available for lending, the account-opening system, operational processes, risk management and other technical issues.
Once the mechanism is in place, it will remove one of the annoying kinks in the market – the conflicts brokerages face between proprietary trading and securities lending.
However, the burden of protecting the interests of minority investors won’t disappear; it will pass to the intermediaries. It is therefore important that regulators carry out suitable due diligence on these companies, checking capital strength and creditworthiness. The best course of action would be to establish several intermediaries with strong government ties or backing and run a trial program so as to convince investors of the mechanism’s safety and legitimacy.
Of margin trading and short selling, the former is more important in the current climate as it is a clear source of liquidity. With more domestic initial public offerings coming in the second half of the year – notably those by overseas-listed Chinese firms and foreign multinationals – Beijing is under pressure to ensure that demand will be strong.
Beyond this, the government’s principal role will be regulation. As margin trading and short selling grow, with a wider variety of participants, so does the risk attached – and this means swift action must be taken against those who break the rules. China’s brokerages have run into trouble before and it has cost the government a lot of money to clean up the mess.
As products become more sophisticated, the parties responsible for selling them must appear whiter than white.