China’s regulator puts curbs on short selling amid a stock market downturn

The backstory: Back in 2010, China introduced short selling to its stock market, allowing investors to make a profit when stock prices fall. Essentially, short selling is a strategy where investors bet on stocks they think will drop. They borrow shares and sell them, then wait for the prices to dip so they can buy them back cheaper and return them to the lender, pocketing the difference. It's a win if the stock falls, but they stand to lose money if the stock price actually goes up.

Over the past few years, Chinese and Hong Kong markets have seen a stock rout that’s wiped out over US$6 trillion since 2021. The main culprits? For one, China’s real estate sector has not been doing well. A perfect example is Evergrande's 2021 default, which ended up triggering a court-ordered liquidation earlier this week. And China’s economic recovery post-COVID has been slower than hoped. Geopolitical tensions between Beijing and Washington haven’t helped either. At the same time, high youth unemployment, declining exports and mounting local government debt have added to the signs of economic trouble.

More recently: In October, regulatory bodies tried to boost the slumping stock market by tightening short-selling rules. For example, they said hedge funds had to keep the entire amount for the stock sale in their accounts. Other investors had to have 80%. Then, another rule came in in November, making brokerages limit how big their securities-lending businesses could be.

The development: The China Securities Regulatory Commission (CSRC) has made a big move by suspending the lending of restricted shares on mainland stock exchanges. Restricted shares are often offered to company employees or investors with limits on their sale, but they can be lent to others for trading, like in short-selling. This can put more pressure on the market, especially if it’s in a slump. Firms financing securities also now have to wait one day before transferring borrowed shares from institutional investors to brokerages, who can then lend them to short-sellers. Before, those shares were available right away.

Key comments: 

“The [mainland Chinese] markets were largely muted to this policy change,” said Ken Cheung, chief Asian foreign exchange strategist for Mizuho Bank in Hong Kong.

“Our view is that investor confidence cannot return until the property sector is finally fixed. Ongoing newsflow confirms that the property crisis is still hot and not easy to resolve,” said Kieran Calder, head of equity research for Asia at Union Bancaire Privee. “Valuations are clearly cheap but for good reasons including self-inflicted damage to the tech and real estate sectors.”

“There has been increasing confusion over the Beijing’s policy stance on the economy,” said Nomura analysts in a research note. “The (central bank) did not deliver a much expected cut of its benchmark lending rates last week. Top officials’ comments suggest Beijing is reluctant to seek short-term growth at the cost of increasing long-term risks.”