With world markets plummeting in response to the global credit crisis, China’s investors could only sit and watch. As they nervously waited for domestic markets to reopen after the week-long National Day holiday, the China Securities Regulatory Commission (CSRC) announced it would be introducing short selling and margin lending to help diversify the instruments available to investors.
The announcement was the latest in a series of moves by the regulators aimed at guiding the direction of domestic markets. But while a positive step in the development of the markets, the move has also reinforced uncertainty by obscuring regulators’ long-term intentions.
"We’ve had a lot of internal debate about [regulators’ plans]," said Chris Ruffle, co-chairman of Martin Currie China and director of the China Fund, which has about US$1.2 billion invested in A-shares. "The jury’s out. I really don’t know."
In any event, the Shanghai Composite Index (SCI) fell more than 5% upon reopening. Observers say it wasn’t a rejection of the government’s move, but a reaction to the dismal previous week. In addition to the global financial meltdown, there were other factors weighing on domestic markets: Millions of previously non-tradable shares are reaching the end of their lockup periods, prompting fears that a supply glut would increase downward pressure on the market.
The CSRC originally moved to allay these concerns in April, decreeing that sales of large numbers of unlocked shares must be block trades – private negotiations between buyers and sellers. Later the same month, with the SCI still sliding, stamp duty – the tax paid on share transactions, which was hiked barely a year earlier to calm investor enthusiasm – was cut back. In September it was scrapped.
In a further step to boost market sentiment, China Investment Corp, the country’s sovereign wealth fund, bought shares in three state banks through its domestic investment arm, Central Huijin. The CSRC also stopped reviewing applications for initial public offerings to support prices by curbing equity supply.
Meanwhile, policy tools such as interest rate cuts and reductions in banks’ reserve ratio requirements indirectly shore up the markets by easing lending and stimulating the wider economy.
Most instances of intervention have prompted a short-term rally. The elimination of stamp duty, coming together with the announcement of Central Huijin’s bank investments, pushed up the SCI by 9.46% in one day on September 19.
Alex Guo, head of institutional investments and sales at Tebon Securities, believes these moves have created expectations of government support among investors.
"I think the government will spare no effort to introduce policies which will help prop up investors’ confidence," he said.
In a recent note, Jing Ulrich, chairman of China equities at J.P. Morgan, outlined some possible policies, including share purchases by state-owned enterprises in listed subsidiaries, an elimination of taxes on cash dividends and encouraging insurance and mutual funds companies to support the markets.
Fear of failure
The danger is that the "multi-pronged approach" Ulrich wrote of – featuring monetary and fiscal policy as well as direct market intervention – may be too complicated for investors and so fail to translate into sustainably higher index levels.
"In China, and in many other Asian markets, more so even than in Western markets, the index level is seen as a barometer of something, rather than just an accumulation or a summation of stock prices," said Fraser Howie, author of a book on China stock markets.
"It’s not the CSRC’s job to support the market … It’s the investors that decide what the levels are."
For many investors, the introduction of short selling (which allows an investor to borrow stocks to sell, betting that he can later buy at a lower price and pocket the difference) and margin lending (borrowing money to buy stocks on the expectation they will rise) is therefore a promising and long-awaited development that will help them do just that.
By allowing investors to hedge against risks, short sales and margin loans have the potential to attract more market participants, and also support price discovery mechanisms within the market.
But, says Qiu Yanying, chief strategist at TX Investment Consulting, the instruments introduce risks to individual investors who may not fully understand how to use them. They can also lead to greater volatility, as seen recently in many Western markets when aggressive short-selling fueled steep declines.
Ruffle believes the CSRC has now determined that those are acceptable risks.
"[These instruments] have been mooted many times before and they seem to have always stepped back from the brink … because the market was overexcited and this would be adding more fuel to the flames," said Ruffle. "But now, [the market] is 60% down, so why not?"
The CSRC has named 11 brokerages, including CITIC Securities, Everbright, Haitong, Guotai Junan and Shenyin Wanguo as participants in its short sales and margin loan trial program. However, Howie remains cautious about the scale and effectiveness of the program.
"Let’s keep things in perspective: It’s still going to be for a very limited audience … it’s still a relatively half-hearted attempt," he said.
Such attempts have only exacerbated uncertainty among investors. Many already paid the price earlier in the year, expecting the government would step in.
"There were [expectations] earlier in the year, based upon the government’s previous record," said the China Fund’s Ruffle. "The massacre has taken place … and the cavalry, whether they turn up now, is kind of irrelevant."