International

Why China Is Trying to Curb Short Selling of Stocks

(Bloomberg)

(Bloomberg) -- With a recovery in Chinese shares beginning to sputter, the government has announced some of the most stringent measures yet to curb the practice of short selling in an effort to support the market. 

The country’s market regulator forced investors to put more money aside as surety against short-selling positions, and the country’s biggest stock lender halted the practice of loaning out shares. The measures add to earlier restrictions that have failed to halt the decline. At one point in January, more than $6 trillion had been wiped off the value of Chinese and Hong Kong stocks from their peak in 2021. History shows that clamping down on short selling rarely provides the market with more than a short-term boost. 

1. What is short selling?

It’s a strategy that allows investors to make money in a falling market. Short sellers borrow shares and sell them on, wait for the price to fall, buy the same number of shares at the lower price and hand them back to the lender. They earn a profit from the price difference — as long as the stock falls. But if the shares rise, they lose money.

2. How does short selling work in China?

Short selling was officially introduced to China’s stock market in March 2010 after a trial program in 2008. Only 90 stocks were eligible for short selling at first, but the list expanded over time. By 2024, more than 3,000 stocks and exchange-traded products were permitted to be sold short, according to a list maintained by China CICC Wealth Management Securities Co. Still, brokerages will only lend shares to clients with at least 500,000 yuan ($69,500) in funds, no major default record, and with an account that has been open for at least six months.

3. What has China done to curb short selling?

In the latest move announced on July 10, the China Securities Regulatory Commission approved an increase in margin requirements for short selling starting July 22, while state-owned China Securities Finance Corp. stopped lending securities to brokerages starting July 11. 

Earlier this year, China’s largest brokerage — state-controlled Citic Securities — stopped lending stocks to individual investors and imposed additional conditions on share loans to institutions, according to a Bloomberg report. China Securities Co. and GF Securities Co. banned clients from using margin loans to buy and return stocks they sold short, as this behavior was seen as increasing risk by allowing a client to double down on leverage. Back in October, regulators tightened margin requirements for hedge funds, requiring those wishing to sell a stock short to hold 100% of the transaction value in their account. A subsequent order in November compelled brokerages to cap the size of their securities-lending businesses. 

4. Will the short-selling restrictions work?

Market participants say the curbs are unlikely to give stocks a sustainable boost as the market’s trajectory hinges more on an economic recovery and an improvement in earnings. In a Chinese stocks boom-and-bust cycle in 2015, the government restricted short-selling to force out day traders whose short-term selling and buying was seen as fueling “abnormal fluctuations.” However, the market continued to slide in the following months. In South Korea, stocks staged a brief rally after the country reimposed a short-selling ban in November, yet the Kospi Index later erased most of those gains. A study of short-selling bans from 2007 to 2009 found such curbs were detrimental to market liquidity and failed to support asset prices. 

5. Why is short selling controversial in China?

Short sellers are often criticized in China for the way they generate profits at the expense of almost everyone else. There is a widely held belief that the practice caused a stock bubble to burst in 2015. It attracted further attention last year after some newly listed stocks slid amid a spike in short-selling activity. 

In a number of cases, management or cornerstone investors lent shares to brokerages during lockup periods for use in short selling. Regulators reined in the practice in October. Since the restrictions were implemented, the outstanding amount of stocks lent out by strategic investors has fallen by almost 36%, according to the China Securities Regulatory Commission. 

6. What else can the authorities do to boost stocks?

Limiting short selling isn’t the only tool Chinese officials have used to shore up the ailing stock market. Higher trading activity in some major exchange-traded funds was one sign of potential buying by state-related bodies. In 2023, sovereign wealth fund Central Huijin Investment Ltd. boosted its stake in four major banks. Bloomberg reported in October that the government was also considering the formation of a state-backed stabilization fund to buy shares. 

Exchanges frequently provide “window guidance” to reduce selling by mutual funds, while guiding other state-backed entities such as insurance funds, brokerages and the national pension fund to buy shares. Top financial regulators have done little to “talk up” the market during the latest rout. If they choose to start doing so, that may give confidence at least a temporary boost. 

©2024 Bloomberg L.P.