Short selling tests China’s zeal for market reform
As the novel coronavirus swept the world this year, Chinese hedge fund manager Yuan Yuwei made lucrative short-selling bets against stocks such as New York-listed Starbucks Corp, Yum China Holdings Inc and Walt Disney Co.
At home, he barely bothered.
“Short-selling is too inefficient in China. Either there are no available stocks to borrow, or it takes too long,” said Yuan, who runs a global macro fund for Olympus Hedge Fund Investments.
Short sellers sell borrowed shares in the hope of buying them back when prices fall and pocketing the difference. Those such as Carson Block of Muddy Waters and Dan David of Wolfpack Research have made their name shorting Chinese stocks but, like Yuan, their bets have been against stocks in New York or Hong Kong, not Shanghai or Shenzhen.
This could be about to change. Last Friday, regulators relaxed short-selling rules for Shenzhen’s $1 trillion (805 billion pounds) startup board, ChiNext, for domestic market participants. They are also considering letting foreigners borrow or lend mainland stocks to short.
Such reform could increase competitiveness and bring China’s markets a step closer to more robust capital-raising centres such as New York and Tokyo.
Shares loaned for shorting in Shanghai and Shenzhen as of June 16 totalled $3.96 billion versus a stock market capitalisation of $8.9 trillion – a ratio of 0.044%, official data showed.
While markets do not calculate short data in exactly the same way, figures from IHS Markit show short interest in the United States of $780 billion, or 2.4% of market cap, and 1.5% for Tokyo.
Due to reform, however, Broker TF Securities estimates short selling in China is likely to grow 10-fold this year and double next year.
Others point to myriad hurdles – both operational and cultural.
“In the short term, many obstacles are insurmountable,” said Wang Li, chief executive of hedge fund Full Harvest and former BlackRock money manager. “Little has changed after so many years, so I’m a bit disillusioned.”
Friday’s changes mark a major shift since 2015, when regulators blamed “malicious” short sellers for illegally “manipulating” the futures market and triggering a crash.
Keen to attract international money, regulators said they are more receptive to shorting as a hedging tool used by long-term investors and as a means of profiting by betting against stocks deemed over-valued.
Regulators also hope it could act as a stabilising force if short sellers’ bearish views help limit speculative bubbles.
Their ChiNext changes, likely effective from August, are part of reforms to the board’s listing system.
Under these reforms, a wider group of domestic participants, including strategic investors, mutual fund managers, pension funds and insurers, will be allowed to lend stock.
Investors will also be able to short stock as soon as it debuts, compared with the main board’s three-month lag.
While borrowers and lenders must still conduct transactions through China Securities Finance (CSF), both will be given greater scope to negotiate deal terms.
The next development participants are watching for is allowing foreigners to short – and lend – mainland shares.
“I’m optimistic that we can see more progress this year,” said Lyndon Chao, head of equities and post trade at ASIFMA, which represents global asset managers and brokers in Asia, and regularly discusses market issues with mainland officials.
Foreigners seeking to hedge mainland exposure – which elsewhere would typically involve stock shorting – can currently only short index futures.
While reform is welcomed, participants said implementation may not be straightforward. One problem is finding shares to borrow.
“Many Chinese institutions trade frequently for quick profit making them unlikely lenders,” said Full Harvest’s Wang.
Another issue is the cost of a centralised system, designed to ensure government oversight.
“When you have CSF as a middleman, you add friction. They also charge you another two percentage points,” said Fang Ming, vice general manager of hedge fund house MingShi Investment.
Fang and others said allowing participants to set their own terms will help, but not solve, issues created by having an intermediary.
The cost of borrowing mainland-listed stock is more than 8% annually of its value, versus 0.9% to 1.2% in Hong Kong, according to brokerage data and people familiar with the markets.
The reforms come as support for short sellers publicly calling out potential problem companies has grown following a series of accounting scandals, such as that involving Luckin Coffee Inc , the U.S.-listed Chinese coffee chain that in April said executives falsified last year’s sales.
Luckin’s sales growth had been questioned two months previously in an anonymous report publicised by Muddy Waters.
Olympus’ Yuan said a more open short-selling mechanism can help root out problem companies.
“You need short sellers to shoot them down and kick them out. Otherwise, they harm investors.”
Chinese regulators have vowed “zero tolerance” toward listed company fraud. The ultimate test for their newfound acceptance of shorting will be whether they let short sellers fire those shots, rather than punishing them as in 2015.
“I could write articles criticising some listed companies, but I need to be very cautious, and the wording has to be gentle,” Xin Chen, professor at the Shanghai Advanced Institute of Finance, told venture capitalists in a recent video seminar.
Wolfpack’s David put it more simply: “Without some form of freedom of speech, short selling cannot exist.”
Source: Reuters (Reporting by Samuel Shen and Alun John; Editing by Jennifer Hughes and Christopher Cushing)