China Limits Stock Market Short Selling to Curb Volatility

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Investors monitor screens showing stock market movements at a brokerage house in Shanghai on July 29.

Photographer: Johannes Eisele/AFP/Getty Images

Chinese regulators restricted short selling of stocks, freezing out day traders, in their latest step aimed at stabilizing the world’s second-largest equity market.

Investors who borrow shares must now wait one day to pay back the loans, according to statements from the Shanghai and Shenzhen stock exchanges issued after the close of trading on Monday. This prevents investors from selling and buying back stocks on the same day, a practice that may “increase abnormal fluctuations in stock prices and affect market stability,” the Shenzhen exchange said.

Under the old T+0 rule, “you can go short in the morning and cover your shorts before market close the same day and lock in your profit, if your bet is right,” Xian Liang, a San Antonio, Texas-based portfolio manager at U.S. Global Investors Inc., said in an e-mail. “Now with T+1, you can’t cover your short position in the same day, and have to wait till next day at the earliest. This new rule should discourage speculative short sellers -- day traders -- and help mitigate intraday volatility.”

China is taking unprecedented measures to stem a stock rout that has wiped out almost $4 trillion in market value since mid-June. Earlier on Monday, the Shanghai Stock Exchange warned two trading accounts for making a “large amount of sell orders affecting security prices or volume.”

Accounts Probed

The exchanges have frozen 38 accounts, including one owned by Citadel Securities LLC, as authorities probe whether algorithmic traders are disrupting the market.

The adoption of the T+1 rule for short selling won’t affect normal margin trading and securities financing and will help safeguard market stability, the Shenzhen exchange said in the statement that was posted on its microblog.

In a short sale, traders sell borrowed stock, anticipating the price will drop so they can profit by buying back the shares at a lower price. China already bans investors who buy shares from selling them until the next day and now such intraday trading restrictions have been expanded to short sellers.

A lot of algorithmic traders, or those who use computer-automated orders to buy and sell stocks, sold short the shares and covered their positions during the day, increasing market volatility, according to Gabriel Wang, an analyst at Aite Group, a research and consulting firm.

Algo Trading

The new rule discourages such practices because short-sellers now have to leave their bets open overnight, making them vulnerable to any market-boosting news before trading opens the following day, he said.

“They are targeting algorithmic names given regulators suspect the naked short sellers are causing volatility,” Wang said by phone from Boston.

The new rule will hurt brokerages because it will reduce short selling, cutting their commissions from the securities lending business, said Wang.

Combined revenue from margin financing and short selling business from Chinese securities firms amounted to 44 billion yuan ($7.1 billion) last year, accounting for 18 percent of their total sales, according to Wang.

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