Jake's View

Era of exploiting ‘regulatory gaps’ to make a killing is rapidly coming to an end

A mug’s guide to the actions of the ‘troublemakers’ who tread the fine line between sound investment management and manipulation

PUBLISHED : Wednesday, 15 February, 2017, 5:12pm
UPDATED : Wednesday, 15 February, 2017, 11:27pm

Mainland regulators and prosecutors are tightening the screws on traders and corporate raiders who are perceived to have taken advantage of regulatory gaps to enrich themselves, particularly during the 2015 equity market crash that wiped out trillions of wealth.

- SCMP, February 14

I think that bit about “taken advantage of regulatory gaps” best tells the story here. Regulations did not cover what these people did. This leaves me with some questions to ask: Let me also propose the answers:

What did these people do that was so evil although not prohibited by regulation?

They enriched themselves during the 2015 market crash and, by implication, contributed to the severity of that crash through the ways they dealt on the market.

Was that illegal?

There were regulatory gaps.

Don’t squirm around the question. Does the law require that we comply with regulations that do not exist?


Then in what way did these people break the law?

They were troublemakers. They embarrassed the government of China.

Is that illegal?

Yes, it is a breach of China’s Four Cardinal Principles. Unfortunately, these principles were devised in part to reject capitalist financial mechanisms and are thus not easily invoked to charge people with failing to observe rules of conduct in capitalist finance.

So with what are we to charge them then?

Oh, insider dealing, market manipulation, that sort of thing, bad stuff, you know.

Did someone really have inside information that the booming Shanghai stock market would suddenly tip over in mid-June 2015 at more than 5,100 on its major index and then fall by more than 40 per cent in little more than two months?

No. Well, maybe Madam Gypsy and her tarot cards did.

Right, let’s try market manipulation then. How do you make an entire market fall by 40 per cent in two months through manipulation?

You short it, you sell millions of dollars worth of stock that you do not own in ways that allow you to delay delivery of the stock to the buyer.

Only millions of dollars worth?

Well, billions if you want to push down an entire stock market by 40 per cent in two months. Okay, maybe you would need hundreds of billions for such an objective. And now here is the famous old American speculator, Daniel Drew, on the subject of shorting: “Him what sells what isn’t his, must buy it back or go to prison.”

What happens when you have to buy back all this stock that you shorted?

Oh, then you have to very careful that you don’t push share prices up as much in buying them back as you pushed them down in shorting them, because then you might lose money.

But isn’t this exactly what would happen if the market was in fact fundamentally strong and the weakness you induced by shorting it so massively, was only artificial? Would it not very likely bounce back up further than you pushed it down?

Not necessarily with a single small stock.

But we are talking here of an entire stock market with a market capitalisation of more than 50 trillion yuan. Is that really just like putting a small illiquid stock into play?


So if these troublemakers did actually short the entire market massively and did succeed in covering their shorts at much lower prices, doesn’t it argue that the market was in fact fundamentally weak, that they recognised it and sold for legitimate reasons? Isn’t that just sound investment management rather than manipulation?

Yes, but they are still in breach of the Four Cardinal Principles by embarrassing the government of China making it more difficult for industry to squeeze money out of the public on the market. They are still troublemakers.

With what will we formally charge them then?

Inside information, market manipulation, that sort of thing. We’ll find something somewhere, don’t worry. We’ll get ‘em yet.