Brokerage executives have been detained, futures markets have been more or less shut down and tougher rules may squeeze out algorithmic trading.
Yet behind the scenes, China’s securities market reforms are picking up speed again, six months after being set back by a $5bn equities rout.
Among the signs of change: two foreign banks are close to getting securities licences, discussions have been revived about a new stock market board in Shanghai for technology startups, and legislative approval for a more flexible system of approving initial public offerings could come as soon as this month.
China plans to end the cumbersome process under which the China Securities Regulatory Commission pre-approves terms of all IPOs, and shift to a simpler and faster registration system. The State Council, China’s cabinet, will seek approval from the nation’s top legislature this month to roll out the new system, the official Xinhua News Agency reported, indicating that the new regime could be in place early in 2016.
Chinese officials may be more confident about reviving the reform agenda after stocks rebounded, with the Shanghai Composite Index up 20% from an August low. Meanwhile, concerns about a ballooning debt burden are prodding China’s reformers to allow greater access for foreign securities firms and to speed up plans to make the IPO market more efficient, providing relief to capital-hungry companies.
“The government is back to pushing for reform in the capital market after the efforts were sidetracked by the market rout,” Scott Hong, a Hong Kong-based analyst at CIMB Securities, said. “For next year, we can expect the start of IPO registration system and more opening of the securities industry to foreign players.”
What is different now, compared with the reform push that ground to a halt during this summer’s market swoon, is a more stringent attitude toward leveraged investing and short-selling. Unwinding of margin debt added to turbulence once the stock market faltered, and authorities have blamed tactics such as short-selling for worsening the rout. In a short sale, an investor bets on anticipated declines by selling borrowed securities, hoping to buy them back later at a lower price.
Stock market investors went on a borrowing spree earlier this year, pushing margin finance to a peak of more than 2tn yuan ($310bn) in June and drawing on unofficial funding sources such as online lending sites. With China’s financial markets still largely insulated from the outside world, the leverage helped inflate a bubble that burst in June.
“The capital market is still not fully-functioning to optimise capital allocation,” said Lu Wenjie, a Shanghai-based strategist at UBS Securities Co. “Investors face restrictions to move capital freely across the border, and have limited investment options in the domestic market. All these exacerbate the distortion in credit risk pricing and the bubble in stock valuation.”
After largely sitting back while leveraged investing drove share prices higher in the first half of the year, China’s regulators have now cracked down, banning online lending for stock purchases and imposing tougher margin requirements on loans from brokerages.
China showed this year that it can quickly reverse course on market reforms and could do so again, if, for example, stocks tumble again.
Trading volumes on China’s equity-index futures market, once the world’s most active, have collapsed after regulators raised margin requirements, tightened position limits and announced investigations into “malicious” short sellers after the summer’s crash. Authorities also plan to increase their oversight of algorithmic traders whose strategies were said to have fuelled market volatility. “There’s no question that regulators will loosen up control, but they might adjust and tighten up again depending on market conditions,” said Chen Xingyu, a Shanghai-based analyst at Phillip Securities Research.
Concerns about leverage are also a factor in plans to streamline the IPO process and give Chinese companies better access to equities funding. With Chinese banks facing rising non-performing loans and increasingly reluctant to lend, domestic bond issuance of 12.1tn yuan so far this year is almost double the amount in 2014. At least seven companies have defaulted on bonds this year, up from only one in the years since the onshore bond market started in 1981.
The need for capital has meant that this year’s shutdown of the IPO market, which lasted from July to November, has been much shorter than the year-long freeze that started at the end of 2012 to combat a previous market downturn. China aims to lift the contribution of so-called direct financing, which includes equities and bonds, to one-fourth of total funding by 2020 from less than one-fifth in 2014, People’s Bank of China Governor Zhou Xiaochuan, wrote in an article last month.
“The government didn’t give up on its big plan for the stock market, which will help companies get financing and the economy transform into a more sustainable model,” said Polar Zhang, a Beijing-based analyst at BOC International Holdings.