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Quant Hedge Funds Dealt Fresh Blow From China’s Short-Sale Curbs

An electronic ticker displays stock figures in Pudong's Lujiazui Financial District in Shanghai, China, on Monday, Feb. 19, 2024. Chinese stocks saw modest gains as onshore traders returned from the Lunar New Year holidays, with broader caution toward the market offsetting buoyant travel and spending data. (Raul Ariano/Bloomberg)

(Bloomberg) -- One after another, the money-making trading formulas for China’s quantitative hedge funds are disappearing.

After blaming quants for roiling the stock market and phasing out their leveraged market-neutral strategy earlier this year, regulators are deepening restrictions on short selling, jeopardizing long-short products that manage an estimated 50 billion yuan ($6.8 billion).

In moves that are set to make shorting more difficult and expensive, the China Securities Regulatory Commission approved an increase in margin requirements while major stock lending provider China Securities Finance Corp. will suspend its business of lending securities to brokerages. 

The steps, coupled with more explicit pledges to raise the costs of high-frequency trading, are piling up pressure on quants that have this year been hit by trading curbs and tightened rules ranging from fundraising to programmed trading. Private stock quants’ combined assets under management slumped by 35% in the first half to 780 billion yuan as of June 30, as all but one strategy shrank, according to Citic Securities Co. estimates.

“The new rules mean hedge funds that are heavy on long-short strategies will have a hard time, as they may not be able to borrow enough securities for their positions,” said Li Zhen, a partner at hedge fund Shanghai Milinsight Investment. Instead, they could be forced to shift toward strategies where they hedge positions with stock index futures, a move that would push down excess returns. 

While the latest measures may lift market confidence to some extent, they will have a “relatively big” impact on stock long-short products that currently manage around 50 billion yuan, according to a Huachuang Securities Co. report. Costs are likely to rise because other channels to borrow securities are much smaller, while higher margin requirements will erode returns, leading to a potential shrinkage in the strategy, analysts led by Liu Xiaowei wrote. 

The long-short strategy, which involves betting that different stocks will rise or fall, lost an average 1.2% in the first half, beating an 8.4% loss among long-only quant strategies, according to data compiled by Citic Securities. The benchmark CSI 300 Index gained 0.9%, after a slump early in the year. 

About 60% of stock long-short products tracked by Shenzhen PaiPaiWang Investment & Management Co. recorded a positive return this year as of June 30, compared with about 40% among long-only funds. 

Chinese quants are going through a shakeup after many suffered record drawdowns during the stock market meltdown early in the year. While outperformers are gaining new clients, some have suffered with assets slumping. 

Regulators have already banned securities brokerages from lending stocks to investors on an intraday basis, effectively putting an end to a quant strategy that involved same-day settlement of trades relying on borrowed stocks. Officials also phased out a leveraged market neutral strategy known as Direct Market Access products, which helped some smaller players boost assets last year. 

--With assistance from Mengchen Lu.

©2024 Bloomberg L.P.