Photographer: Imaginechina via AP Images

Trigger-Happy Stock Traders Show Why Regulation Is Hard in China

  • Shares tumble on report of wealth-management product curbs
  • Officials want to reduce use of leverage, Hengsheng says

Volatility is re-emerging in the world’s second-biggest stock market.

Chinese shares plunged Wednesday, with a gauge of smaller companies tumbling 5.5 percent, as people familiar with the matter said the China Banking Regulatory Commission is discussing stricter curbs on wealth-management products. A measure of the Shanghai Composite Index’s short-term volatility doubled, after sinking to a two-year low on Monday.

The market’s exaggerated response shows what’s at stake for China’s watchdogs as they attempt to reduce risk in the financial system while avoiding going too far and provoking another crash in the $6.1 trillion stock market. The Shanghai Composite is down 15 percent this year, among the world’s worst performers.

“Many banks have been investing in WMPs to funnel money into the stock market,” said Francis Cheung, head of China and Hong Kong strategy at CLSA Ltd. in Hong Kong. “It’s non-transparent, so I understand why regulators would try to act. But if this causes too much correction, then they will get worried. The No. 1 priority is to maintain a relatively stable stock market.”

Stocks were whipsawed again on Thursday, with the ChiNext Index accelerating declines in late morning trading to fall 1.8 percent by the lunch break. The gauge pared its drop to 0.7 percent by the close, while the Shanghai Composite added 0.1 percent.

The CBRC’s proposed crackdown on the $3.5 trillion WMP market was first reported by the 21st Century Business Herald, which said that all lenders may face caps on the investment of proceeds in stocks. Draft rules state that cash from “mass market” wealth products can only be invested in money or bond markets, not domestically-listed shares, a person familiar with the matter told Bloomberg. The rules are pending feedback from banks, the person said.

For more on the planned rules, click here.

China’s securities regulator has already restricted the use of leverage by structured asset management plans, and was said to warn brokerages to do better due diligence when raising money for companies. The Shenzhen Stock Exchange will demand better disclosure and limit speculation on stocks in popular industries such as virtual reality and artificial intelligence, according to a statement in the Securities Daily Tuesday. China will curb asset bubbles, the official Xinhua News Agency reported the same day, citing a government statement after a Politburo meeting chaired by President Xi Jinping.

On Wednesday, that all added up to a bad day for stock investors. The ChiNext Index of small-company shares sank by the most since June 13, the Shanghai Composite Index fell 1.9 percent and the Shenzhen Composite Index lost 4.5 percent.

Trading volume in Shanghai surged to the highest since April, while a gauge of 10-day price swings doubled. The Shanghai gauge trades at 12.8 times projected 12-month earnings, compared with more than 31 times for the ChiNext.

“There’s an obvious trend of regulators wanting to strengthen market monitoring and lower the use of leverage in financial markets to control risks,” said Dai Ming, a fund manager at Hengsheng Asset Management Co. “Under such circumstances, ChiNext is especially vulnerable, given its high valuations.”

For a Gadfly commentary on banks’ exposure to WMPs, click here.

China has been tightening rules on WMPs since late 2014. The products are a key reason behind the growth in the shadow-banking industry, which Moody’s Investors Service estimates is worth more than 50 trillion yuan, and have been used by some financial institutions as a way to extend funds to risky borrowers and evade capital requirements. WMPs are sold by banks but often stay off their balance sheets.

The latest CBRC draft imposes restrictions on banks with less than 5 billion yuan of net capital or fewer than three years of experience with wealth products, the person said. Larger, better-capitalized lenders would be allowed to conduct "comprehensive" wealth business, and allowed to put the money into equities and other riskier “non-standard assets” such as loans, the person said.

“The government thinks tighter regulation is needed because investments from WMPs helped fuel the stocks bubble last year and then contributed to the crash," said Larry Hu, head of China economics at Macquarie Securities Ltd. in Hong Kong. “Some of them are just like black boxes, and neither the government nor the investors know for sure which products the banks invest the money in.”

— With assistance by Justina Lee, Tian Chen, and Kyoungwha Kim

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