Inspections on “Quantitative Hedging” Product Collaboration

The CSRC will conduct special information technology inspections on a number of securities and futures operating institutions (i.e., securities houses, fund management firms or futures brokers engaged in securities or futures related businesses, collectively the “Institutions”), starting from the middle of August, as part of a plan formulated early this year. In its announcement of such inspection on August 14, the CSRC specifically mentioned its plan to inspect the asset management operations of such Institutions. Last Friday, the China Securities Times (STCN) reported that a few securities houses had already received notices from the regulator regarding the inspections on “quantitative hedging trading”.
The STCN news report summarized the contents of the notices as follows. The object of the inspection is asset management products, including products issued by the Institution itself or issued by others, but connected to such Institution; and the focus of the inspection is “quantitative hedging strategy”. The notice also identified the CSRC’s main concerns about “quantitative hedging trading”; specifically, impacts (i) on the market when multiple products are using similar strategies; (ii) on the trading system; and (iii) on market justice and the interests of public investors.
Through the inspections, the CSRC will gather information regarding the method of participation in “quantitative hedging trading” by the Institutions under its jurisdiction. For self-issued products, the inspection scope includes, but is not limited to, the strategies adopted during the order submission and execution processes, the conditions triggering the submission of orders, the processes of submitting and executing orders, and the risk control measures adopted by such Institutions. For products issued by others, but connected to such Institutions, the scope of the inspection includes whether the Institutions are engaged in “quantitative hedging trading”, whether a self-developed “quantitative hedging trading” platform is offered by such Institutions, and the risk control measures adopted by such Institutions.
The regulator specifically emphasized that the scope of inspections on risk control measures shall include (i) whether the provider of the trading channel has knowledge of the investment advisor’s “quantitative hedging strategy” and of any related significant risks; and (ii) whether the product manager that is connected with an outside “quantitative hedging” platform acknowledges the risk management conditions of such outside “quantitative hedging” platform.
Our Observations
We are of the view that, following the A-share market crisis, the above supervisory measures are to be expected. Enhancement of supervision and emphasis on risk control will definitely bring changes to the product collaboration model of third party investment advisors and the Institutions. For existing and ongoing collaborations with third parties, the collaborating Institutions must explain to the regulator the nature of the strategies used in their products, analyze the impact of their strategies on the market and ensure the adoption of appropriate risk control measures. For potential collaborations, we anticipate that the attitude of the Institutions may turn from open to conservative and that the Institutions might follow stringent criteria in choosing partners and strategies for collaboration.
The objectives of the above supervisory measures are very clear — the relevant asset managers and Institutions connecting trading platforms shall have sufficient knowledge about the strategies of the relevant products or platforms, have the ability to evaluate their impact on the market, and bear the responsibility of risk control. From a practical point of view, however, the achievement of such objectives still depends on the relevant parties’ abilities and experience, which may be derived from the product collaboration process.
We believe that, in responding to market needs, collaborations with third parties will continue, though such collaborations will definitely be facing a more stringent supervisory environment and uncertainties caused by the supervisory policies.