Chinese government gaming itself in the markets

Published 17th February 2016, 15:30 HKT

At a State Council meeting on Monday, Li Keqiang criticised the nation’s regulators for their handling of the stockmarket collapse, in particular their “internal management issues”. The Chinese Premier is correct of course, only the same could just as easily apply to other government and state owned institutions operating in the Chinese stockmarket.

The most embarrassing aspect of the Chinese government’s interventions in the stockmarket is evidence of politically connected players gaming the system for private gain, in the process denting the government’s plans to develop the stockmarket as an important fundraising channel for alleviating the nation’s corporate debt load, now at 200% of GDP.

The actions of some elite government players have in the short term damaged the IPO process, a vital fundraising tool for China’s tech sector, and even threatens the government’s long term reform plans for part privatisation of state owned enterprises.

The stockmarket breakdown also exposes a dated political system overtaken in recent years by financial reform and more sophisticated domestic market players, a shock to the established political order accustomed to dividing spoils in a state rigged stockmarket. The more the Chinese Communist Party seeks to impose its political will on the markets, the more it is undermined by those within its own ranks. 

Once Beijing introduced measures to curb property market speculation and signalled its support for a bull run in mid 2014, smart money investors began building positions in the equity markets. By the time the bull run was in full swing in 2015, public disclosures reveal hedge funds, company executives and other large shareholders were already selling out, in all probability, to retail investors. Some of these hedge fund managers have yet to return to the equites markets.

In mid 2015 when the Shanghai Composite began its death spiral from 5,000 points, the government ordered state banks and stockbrokers to prop up the markets as part of its ‘National Team’. An easy way for investors to exploit these moves at the time was to buy CSI 300 contracts at the open and sell at the close, benefiting from the ‘National Team’s regular intervention in afternoon trading.

An even easier method was to work in a stockbroker on the ‘National Team’, and front run their trade orders for that day. Citic Securities, the brokerage arm of China’s largest state owned financial conglomerate, was one such ‘team player’. By December 2015 at least seven of its senior executives had been arrested on insider trading charges relating to ‘National Team’ trading.

If front running the government was not enough, Citic Securities was over the same period offering cross border swap products which allowed international hedge funds to short the Chinese stockmarket. Not much in the way of patriotic love from a broker run by China’s elite.

With the central authorities outflanked by more sophisticated government players, it was forced to effectively shut down the market. Trading in up to 1,200 shares were suspended, whilst restrictions were placed on short selling, large shareholders reducing holdings in the market, and CSI 300 index futures trading. To regain political control, police were despatched to investigate trading activities in domestic hedge funds and brokers.

But even before company shares are traded on the secondary market, political insiders are already gaming them in China’s IPO system. New research by Zhou and Li of Beijing’s Central University of Finance and Economics reveals that 74% of private firms allowed to float on the stockmarket have political connections.

Moreover, those firms with political connections are more likely to report a significant deterioration in financial performance post listing. Evidence that China’s elite are stagging IPOs, then selling dud stocks to private investors.

The combination of the stockmarket crash and government players trashing the IPO system risks derailing the government’s plans to offload a trillion US dollars worth of state assets as part of SOE privatisation plans, as well as stunting efforts to replicate the Silicon Valley model. With doubts hanging over the IPO route, it is more difficult than ever for high grow tech firms to attract seed investment.

To overcome this, Shanghai authorities have this month taken the drastic action of promising to compensate local investors for venture capital related financial losses. In a related move, the CBRC is planning a pilot program which would allow commercial banks to directly invest in tech start ups for the first time. These two moves just made it even easier for government players to game the IPO system.

Despite running battles with state players in the markets, Xi Jinping is still sticking to his philosophy of politics over the markets, which only seems to earn him more guest appearances on the front cover of The Economist, and less chance of an efficiently functioning stockmarket.

Perhaps he ought to heed the advice of Chinese politician and businessman Yuan Geng, who passed away just before Chinese New Year. Geng was a proponent of the reform and opening up policy, but on the condition these actions did not challenge the Party. Judging by the warm obituaries Geng received on Chinese television, there are still those keen to remind the current administration of the value of markets over politics.

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