Bears and short-sellers dare not wade into China’s equity slump for fear of regulator’s wrath
A curious thing is happening in Chinese stocks, as the benchmark index of Asia’s largest bourse hurtles toward the worst bear market slump since 2015: the short-sellers are nowhere in sight.
Short interest was a minuscule 0.8 per cent of outstanding long interests on July 25, according to China Securities Finance’s data, which means there are far fewer investors betting on the declining market than traders who are invested in advancing prices.
The gap leaves investors vulnerable without a hedge to cushion their bets, so they just give up and leave the market. What follows next is further declines in stock prices as more investors clear their positions, traders said.
“The best way for us to hedge against risks in a declining market is to cut stock holdings,” said Dai Ming, a fund manager at Hengsheng Asset Management in Shanghai. “Short-selling bears pretty high costs and there are not many stocks that can be easily borrowed.”
In some ways, it is a crisis of the regulator’s own making. The China Securities Regulatory Commission (CSRC) had never looked favourably upon the practice, where traders are allowed to sell securities – even without owning them – with a plan to buy them back at a lower price in future, pocketing the difference as profit.
The regulator made 991 stocks and exchange-traded funds available for short-selling, out of a total of 3,586 equities and funds in the world’s second-largest capital market. Since its 2012 inception, short-selling has expanded fivefold in China, less than half the growth size of leveraged purchases over the same period.
The outstanding balance of shorted stocks on the Shanghai and Shenzhen exchanges rose to 7.62 billion yuan (US$1.12 billion) on July 25, the highest level since June 2015, but still a tiny fraction of the 885 billion yuan in long interests. By the end of last week, the balance had dropped to 7.42 billion yuan.
China’s stock market rout in the summer of 2015 wiped out an estimated US$5 trillion in value from the country’s publicly traded companies, with the benchmark Shanghai Composite Index slumping 44 per cent.
Short-sellers, a favourite of hedge funds and day traders, were cited as the main culprit, provoking the wrath of then securities regulator Xiao Gang. An investigation team was set up to screen for what the regulator called “illegal manipulation” across markets, while 19 accounts were suspended from short-selling for a month.
In a move designed to calm the market, the regulator also ordered China’s biggest brokerages to stop lending shares to traders, increased transaction costs and restricted the number of daily short contracts investors could open on index futures.
The result was a one-way bet for most Chinese equities
“There are relatively few sources of securities available for short selling and the costs of doing that are high,” said HSBC Jintrust Fund Management’s fund manager Shi Xingtao, who is not buying shares of property developers, steelmakers and other battered cyclical stocks. “So, we fund management firms barely use it.”
Another reason dampening the practise is the cost of borrowing. The annualised interest rate charged on lending stocks stands at 8.35 per cent at big brokerages such as Citic Securities and Galaxy Securities, almost double the one-year prime lending rate at commercial banks.
Citic Securities, China’s biggest publicly trade brokerage, reported the total value of its short-selling business was 160 million yuan in 2017, compared to 70.8 billion yuan in its margin-trading section, according to its annual report.
However, analysts said it may be too late to deploy short selling strategies, given that Shanghai’s main share index had already slipped into a bear market, and is down 13 per cent so far this year.
On the mainland, it is common for large brokerages to reduce their stock holdings during periods when sentiments turn bearish, which in turn reduces the available supply of shares that can be lent to short-sellers.
Because brokerages do not own a broad range of stocks, the practice of shorting specific companies, including lesser-known companies suspected of accounting fraud or other operating difficulties, is more difficult in China than in the US or Hong Kong.
At least five companies listed in Hong Kong, four of which are mainland Chinese, were targeted by short-sellers in the first half. That compared with a record six for the whole of 2017, according to global accounting giant Grant Thornton.
“In a bear market, brokerages normally don’t have lots of stock,” said Wei Wei, a Shanghai-based trader with Huaxi Securities. “Even the stocks with the right fundamentals don’t get added into the pool for short-selling. That’s why China’s short-selling has never taken off.”
Additional reporting by Jane Li in Hong Kong