Client Alert – Continuing Measures To Stabilize Market

It has not been a peaceful week for China’s capital market since last Friday. Led by the CSRC, three exchanges—the Shanghai Stock Exchange (SSE), the Shenzhen Stock Exchange (SZSE), and the China Financial Futures Exchange (CFFEX)—separately implemented supervisory measures to stabilize the market as well as placed restrictions on overly speculative trading. The following alert provides public information in a simplified manner so as to provide a glimpse into the thinking behind such regulatory measures as well as possible future trends in regulatory policy.
1 Supervisory Measures of the Past Week
The CSRC provided the following statements and answers to the media on July 31, 2015:
(1) both the CSRC’s relevant dispatch agency and the SSE and SZSE are presently inspecting certain institutions or individuals whose trading has program trading characteristics, for the purpose of determining their compliance with the “real name” requirement, the source of funds, and their trading strategies, as well as to analyze the effect of such trading on market fluctuations;
(2) the aforementioned inspections stem from the regulators’ concerns regarding the effect of program trading in boosting or pushing down the market, and particularly in the current volatile market, its impact will be amplified because of the existence of certain abnormal trading; and
(3) the CSRC will improve the relevant rules and regulations and strengthen its supervision based on the outcome of the inspections.
At the same time, the SSE and SZSE separately, according to their respective trade rules, announced measures to temporarily restrict a number of stock trading accounts, with such restrictions being set for three months. These accounts were seen as engaging in abnormal trading that violated the exchange’s abnormal trading rules on “frequent placement or cancellation of orders suspected as affecting stock prices or the investment decision-making of other investors.”
CFFEX also issued a series of measures with the aim to suppress over-speculation. These measures include:
(1) starting August 3, 2015, the commission structure of stock index futures will be split into two parts, trading commission and order placement commission, with the trading commission of stock index futures contracts being reduced to 0.0023%, and a charge of RMB 1.00 being levied on each order placed; and
(2) starting August 3, 2015, where an investor engages in stock futures arbitrage or speculative trading, and order cancellations are in excess of 400 times per day per contract or cross-trades are in excess of 5 times per day per contract, such activity will be identified as “abnormal trading.”
Moreover, also on August 3, the SSE and SZSE amended their respective stock lending rules, adjusting the borrowing and returning timeframe for stocks from T+0 to T+1.
2 Our Observations
We note that the purpose of these measures is very clear-cut, namely, to stabilize the market.
Unlike the earlier period in the current crisis where, due to being eager to respond to the market crash, rash investigations of “malicious shorting” and “market manipulation” were conducted, or the market crash was simply blamed on the shorting of stock index futures, the regulatory measures introduced this week are relatively specific, transparent and multilevel, comprised of temporary measures of suspending suspected abnormal stock trading accounts, as well as relatively long-term measures of modifying the trading rules, business rules and fee structures of the exchanges so as to affect market behavior.
At the same time, we note that the present stance of regulators on program trading seems to be neutral and objective. A complete prohibition on program trading was not issued, and the regulators emphasized that the domestic capital market is still emerging and in a transitional stage, and that the regulators should cautiously allow program trading to develop, while still being particularly alert to the amplified effect of program trading in conjunction with abnormal volatility and market manipulation.
The present crisis has caused program traders in China to be brought to the forefront of regulatory focus. We believe that program trading contains stringent requirements on supervision, where the development of the market and technology are forcing regulators to improve technical levels of supervision (otherwise, it will be difficult for regulators to quickly respond to market changes). We also believe that regulators should use this opportunity to gather comprehensive information, and, in connection with the specific circumstances, research and formulate relevant regulatory rules, and not “give up eating for the fear of choking.” But, there is no doubt, due to the current abnormal volatility of the A-share market, the measures and rules issued this week may continue to exist for a short-term period. Only after the market is stabilized will regulators possibly prioritize the formulation of more long-term regulatory rules on program trading.