China’s quant clampdown risks damaging fragile markets for years
CHINESE hedge funds were looking forward to a holiday break from the market turmoil when trouble started brewing last month. One manager had his short-selling orders abruptly rejected by brokers. Another was cut off from the stock market completely. Regulators turned up on trading floors at multiple funds to monitor transactions in person.
As one fund put it, three sessions of chaotic trading “felt like a whole year to us”.
The scenes, extraordinary even by the standards of a market that has long operated under the Communist Party’s shadow, played out in recent weeks in a clampdown that’s rewriting the rules of computer-driven trading in China. The country’s once-booming quant industry has become the latest casualty of Beijing’s campaign to stop a US$4 trillion sell-off in stocks.
While the measures have helped prop up share prices at least temporarily, they raise bigger questions of how far Xi Jinping’s government will go to meet short-term goals at the expense of maintaining some pretence of a free market that’s attracted billions of US dollars from Wall Street firms in recent years.
For international investors becoming increasingly skittish about China, the sudden trading restrictions give them one more reason to stay away.
China saw a record six months of outflows from the equity market until this month, while foreign direct investment is at a 30-year low following unprecedented crackdowns on the tech and property sectors that have stifled growth. China risks losing out further to countries such as India and Japan, which are enjoying a surge in investment.
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“These seemingly panic actions by authorities risk undermining all the good work done in the past two decades to give China access to global pools of capital,” said Gary Dugan, chief investment officer at Dalma Capital Management in Dubai. He said the moves will make “even the most battle-hardened investors” question whether China is worth the risk.
The new restrictions are sweeping. Quant funds, which rely on computer algorithms to carry out trades, will be scrutinised and new entrants will have to report their strategies to regulators before trading. Beijing will also expand the scope of reporting to offshore investors via a mainland-to-Hong Kong trading link.
China’s securities watchdog in the meantime, set up a task force to monitor short selling and could issue warnings to firms that profit from the wagers, sources familiar have said. It even took the extreme step of halting some major institutional investors from selling more shares than they buy during the first and last 30 minutes of trading, they added.
“Quant managers were hit by the biggest Black Swan in quant history,” Shanghai-based Semimartingale Private Fund Management wrote, recapping the wild market swings in a letter seen by Bloomberg.
The crackdown adds to a series of moves aimed at halting a multiyear plunge in equities, which have been slammed by the housing crisis, weak economic growth and lingering tensions with the United States. It also echoes the heavy-handed approach that has been used to clamp down on sectors from the Internet to education platforms.
“The risk premium on Chinese stocks has to go up going forward because some institutions are going to be unwilling to trade this market,” said Arthur Budaghyan, emerging markets chief strategist at BCA Research. “And this is on top of geopolitical concerns that many foreign investors have had about investing in Chinese stocks.”
In recent weeks, Beijing turned its sights on quant funds, which have used their big data models to outperform the market for much of the last three years.
In an early sign of what was to come, Chinese Premier Li Qiang on Jan 22 asked authorities to take more “forceful” measures to stabilise markets as the CSI 300 index hit a five-year low. Beijing then made a surprise move two weeks later to oust the head of the securities regulator, replacing him with a veteran bureaucrat known as the “broker butcher” for his past crackdowns.
Concerned that quant funds were exacerbating declines by unloading big blocks of shares or making short bets, Beijing started by banning some funds from placing sell orders while limiting their ability to make short trades. The China Securities Regulatory Commission (CSRC) said it had discovered multiple cases of market manipulation and “malicious short selling”.