Beijing okays short selling, margin trading and index futures

New tools for professional investors…

According to Bloomberg, the China Securities Regulatory Commission changed the rules last week to allow all three practices on the Shanghai exchange for all Chinese citizens, as well as for the 94 foreign entities that have been approved as Qualified Foreign Institutional Investors(QFII).

…will increase the sophistication of Chinese markets

This is an important step in increasing the flexibility and potentially the liquidity of mainland Chinese equity markets.  Using these tools will doubtless end up increasing the trading skills and sophistication of domestic Chinese investing institutions.

Not an invitation to arbitrage Hong Kong and Shanghai shares, though

But I don’t think this by any means an invitation by Beijing for domestic players or foreigners to try to arbitrage away price differences between shares of the same company traded in Shanghai and those traded in Hong Kong.  Why?

1. Selling the more expensive shares short (unusually, in this case it would be the “A,” or local shares) and buying the cheaper ones (the foreign or “H” shares) isn’t something most institutions can do.  Chinese investors have only limited access to non-domestic stock markets, and even then only in specified formats; among foreigners only QFIIs have access to the domestic market and again only with clearly specified pools of money.

2.  The arbitrage would be financially risky.  A shares and H shares are separate classes of stock, not exchangeable from one class to the other.  In addition, they are traded in different stock markets, and among investors who have sharply different investment universes and risk preferences.   My perception of the history of dual classes, foreign and domestic, in Asia is that the more expensive class (usually the foreign shares) continues to become more expensive until the country in question decides to abolish the two-class structure.

3.  It would be politically risky, as well.  China has followed the lead of other developing countries in limiting the amount of a publicly-traded company that foreigners can own.  But it has gone a step further by keeping the bulk of foreign trading both physically and legally apart from domestic.  Why do this?  –to avoid the destabilizing speculation it witnessed in its own backyard during the Asian financial crisis of 1997.

In the US, we sometimes have a perverse admiration for individuals who can exploit legal loopholes to thwart the intent of government regulation, and congratulate him for having done so.  In China, on the other hand, a group that engineers a stock market decline that damages the country and engenders social unrest, but which they benefit from, may be more likely to be convicted of political crimes and imprisoned for a very lengthy period than feted.  I’m not arguing, here anyway, for one system or the other–just observing that the rules of conduct outside one’s home market may be far different from what one is used to.

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