Regulators must get to grips with China’s stock-market manipulators, but are they up to the job?
Robert Boxwell says the series of missteps amid volatility in China’s markets shows up the scale of the problem
Two cheers for the recently departed China Securities Regulatory Commission chairman, Xiao Gang (肖鋼), who left after not succeeding at the impossible task of propping up China’s overvalued stock markets. He has been replaced by Liu Shiyu (劉士余), who, like Xiao when he started, has no regulatory experience. Not that it would help.
In January, Xiao summed up China’s stock market problems: an “immature bourse and participants, incomplete trading rules, an inadequate market system and an inappropriate regulatory system”. That pretty much covered things, except the real causes of the market rout: overvalued stocks, an overleveraged, slowing economy with excess capacity and little hope for consumer spending to take up the slack. January’s massive issuance of new bank debt would seem to indicate that Beijing is less optimistic than it’s saying about consumption replacing investment in our lifetime.
Meanwhile, as central bank governor Zhou Xiaochuan (周小川), missing in action for months, reappears and stretches linguistically to distinguish between “capital outflows” and “capital flight”, trillions of dollars have left the mainland. Whatever you want to call it, the capital is gone and, because it’s going to repay dollar debts or buy Western companies by the billions, or to buy offshore insurance policies or Vancouver condominiums by the millions, it’s not coming back.
Xiao’s last straw was the spectacular failure of his signature solution to stop the market meltdowns that began last summer: circuit breakers. Circuit breakers have been around since 1988, when the Brady Commission recommended them as a means to temporarily halt relentless selling by institutions so buyers had time to gather and come back into the markets. I spent that spring in a class taught by a senior staff member of the commission, which identified the causes of the October 1987 “Black Monday” crash and fixed them.
The start of the decline “ignited mechanical, price-insensitive selling by a number of institutions employing portfolio insurance strategies and a small number of mutual fund groups reacting to redemptions. The selling by these investors, and the prospect of further selling by them, encouraged a number of aggressive trading-oriented institutions to sell in anticipation of further market declines... This selling, in turn, stimulated further reactive selling by portfolio insurers and mutual funds,” it found.
Picture wide-eyed retail investors in China, heavily leveraged gamblers lured into the markets by government propaganda – “good times are just beginning”, the People’s Daily blared last May – staring at the mayhem on their screens as the 5 per cent circuit breaker approaches. They’re not gathering to buy, they’re gathering to sell, frantically tapping in orders so they can get it done before the next circuit breaker, at 7 per cent, kicks in.
Which is exactly what happened on January 7, the second and final day of the circuit breaker’s short life. The ticker was in relentless free fall, wiping out billions in market valuation in just 14 minutes of trading.
A regulator’s job isn’t to keep markets up, though. It’s to keep them clean and functioning properly. Liu may have a way to go there. Two of Xiao’s former senior colleagues at the regulatory body were detained last year for “serious violation of party discipline”, along with at least seven senior executives at Citic Securities for insider trading. Cracking down on insider trading was one of the supposed centrepieces of Xiao’s regulatory stint.
The first thing Liu should do is look into the market manipulations that have popped up since the arrival of the so-called “national team” of state-owned financial institutions tasked to prop up the market, and figure out who exactly is selling to them. Because it’s hard to imagine that Beijing would tolerate, for example, a trading strategy that lets people buy low in the morning knowing they can sell high to the national team in the afternoon.
Perhaps the national team is selling to itself? If this were to happen in the United States, where regulators don’t care for groups that manipulate share prices, the so-called traders would soon be so-called felons. Hong Kong takes the same dim view of manipulators, as do most well-regulated markets.
If it turns out that members of the national team are selling to one another, say, exchanging losses on one counter for gains on another, it may be the first market where the regulators are heading to jail and the manipulators are the heroes. Liu should tell them to stop, which they should be happy to do, if that’s the case, since it’s a charade and, smart as they are, they understand the impossible task of performing such financial isometrics forever. Perhaps it gave them something to do on what otherwise might have been slow trading days. It was reported last summer that the national team pledged not to sell shares until the Shanghai Composite index returns to 4,500. That could take a while.
As for the recent flurry of attempts at better communication, this should not mean talking to the markets more; it means telling the truth when you talk. The recent redaction of foreign exchange data isn’t a propitious sign in that regard. Since the announcement of China’s new public relations efforts, we’ve seen all sorts of characters rolling out a message, most of them well-groomed with proper podium presence. As cheerleaders, whose overall message can be summed up as, “things aren’t really as bad as they look”, they like to pooh-pooh the stock market meltdown by claiming it’s not linked to China’s real economy.
Perhaps the most surreal among them was China’s ambassador to the US, Cui Tiankai (崔天凱), a career diplomat who somehow joined the fray to expound on economics in The Wall Street Journal recently: “It’s important to remember that China’s stock market is still developing – its value is about 30 per cent of China’s total GDP, compared with 100 per cent in the US. For this reason, China’s stock-market ups and downs shouldn’t be taken as reflective of general sentiment about the Chinese economy or its overall performance.”
Sure. Try telling that to the millions of retail investors who borrowed heavily to get into the game thinking it was supported by the government. The market’s value wasn’t 30 per cent last June. It was 60 per cent and rising on the back of China’s propaganda machine’s stock market circus barkers. More than US$4 trillion of Chinese savers’ wealth has evaporated since then.
If what Cui said is how Beijing looks at China’s stock markets, what’s the point of having them? Stock markets with Chinese characteristics aren’t real stock markets. At the moment, China’s are little more than a mainland Macau. Deng Xiaoping (鄧小平) said the mainland could try stock markets and if they didn’t work, it could close them. That might be an option worth considering if they can’t figure out how to regulate them properly.
Robert Boxwell is director of the consultancy Opera Advisors