Shorting rules drag on Shanghai-Hong Kong Stock Connect prospects
Short sells on the Shanghai-Hong Kong Stock Connect have tallied a grand sum of zero since regulators opened the scheme for leveraged trading nine months ago.
That’s an odd trait for a programme that has seen strong demand from global hedge funds that have just recently gained access to the mainland Chinese market.
The rules technically allow short selling but in practise the players that do the securities lending are barred from the business.
Future demand for mainland shares bought over the cross-border scheme could be dampened if the rules are not eased, people in the industry said. It could also hurt the anticipated connection with Shenzhen’s exchange.
“There’s a limitation on trading strategies for the stock connect. Short selling is a part of that,” said Matthew Chan, head of business strategy at Depository Trust & Clearing Corporation (DTCC).
Daily quotas and operational hitches presented other challenges for global traders looking to access the Chinese market, he said.
In its first year of action, turnover on the connect with Shanghai was low, with average daily northbound investment making up just 0.6 per cent of Shanghai’s daily turnover. That for southbound turnover was less than 1 per cent of the Hong Kong stock exchange’s total.
Mainland regulators have had tough trials with domestic securities lending this year, a business chalked up as a primary culprit for the mid-year market rout. A handful of brokers at China’s biggest securities companies have been detained on charges related to manipulating the market via securities lending.
A change to stock connect rules in March allowed for the first time cross-border shorting of mainland stocks. However, the rules limit participation to brokerages regulated by the securities regulators in China and Hong Kong, cutting out the custodian banks and fund managers that provide liquidity for the leveraged trades. Brokerages seldom put up funds for leveraged trading themselves.
Under the same rules, most of the major institutional investors holding the shares do not qualify to lend them out.
Creating a framework for short selling was a positive step, Cindy Chen, head of securities and fund services at Citi in Hong Kong, said at a conference on Thursday. But the current rules have still corked both supply and demand for securities lending over the stock connect.
“The framework now is too restrictive,” Chen said at an Asia Securities Industry and Financial Markets Association (ASIFMA) meeting. “Both sides need to be relaxed to allow more supply to be in the system and to allow more participants to be the conduit for securities lending.”
The limitations are significant given that northbound trading on the stock connect has attracted the interest of hedge funds, which until last year had been left out of other cross-border investment schemes. By definition, hedge funds take short positions on stock trades in order to lessen risk.
Chen at DTCC noted that limitations on short selling could have an even bigger impact on the Shenzhen-Hong Kong Stock connect due to the smaller and more volatile stocks on the exchange that can make hedging more profitable.
The link with Shenzhen was originally expected to launch by the end of the year but has been delayed until early next year.
Rules preventing short selling would not hurt the prospects of MSCI inducting Chinese stocks into its emerging markets index, MSCI head of Asia Pacific Chris Ryan said at the ASIFMA conference. MSCI chose not to add China-listed stocks to its index in June, just days before the mainland exchange experienced a sharp drop, followed by a government-brokered bailout.