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China, China looks to Strengthen Short Selling Activity

China is planning the setup of a Centralised Securities Lending Exchange to boost short-selling, a move that would add liquidity to its capital markets and help develop the country’s nascent hedge fund industry.

China is reportedly preparing measures to boost the country’s emerging short-selling industry in an attempt to bring more liquidity to its capital markets, according to securities officials and several fund managers. In particular, Beijing is thought to be preparing a new body to help develop the country’s hedge fund industry. The new body which has been given the name of Centralised Securities Lending Exchange which purpose will be to make short selling easier may be launched as early as this March. The China Securities Regulatory Commission which is in effect the market regulator will be the biggest shareholder in the board with other shareholders being the Shanghai and Shenzhen stock exchanges, in addition to brokerage firms and some other financial institutions. At present it is not known exactly which companies will be involved, however, in early 2010 just 6 companies had licenses to trade in securities lending and margin financing. By the end of that year, 25 brokerages had licences to provide a wider range of prime services.

The exchange intends to seek stock from institutional holders like banks, insurance companies and fund management companies in China and make them available to fund managers who want to borrow them for a charge. Short sellers typically stand to make money by borrowing stocks and then selling them in expectation that the price would decline, permitting them to buy back the stock at a lower price and in this way make a profit. So while in some countries, authorities have been looking at curbing short selling on the basis that it can exacerbate volatility and bring certain industries in jeopardy, China is trying its best to bolster the activity to improve liquidity. Proponents of short selling argue that the practice not only boosts liquidity but also provides some income for shareholders who are prepared to lend their stock.

Raymond So Wai-man, dean of the School of Business at Hang Seng Management College was quoted saying that short selling is normally not the only reason behind a market’s fall so it is not a sensible decision to avoid it. He said allowing short selling is a must for the development of China’s capital market and will also serve to discourage the black market.

China’s hedge fund industry emerged in 2010 when the government started permitting index futures, short-selling and margin-trading, allowing institutions to offer such financial instruments; however the activity was hindered by the limited number of stocks available for qualified asset managers to borrow (at present just 285 stocks are permitted to be traded on margin). At the moment, short selling and margin trading accounts for only about 1% of daily deals on the Shanghai and Shenzhen bourses. Recently, Beijing formalised its margin-trading and short-selling system, which was originally introduces as a pilot project, and permitted more institutions to participate. China presently doesn’t permit naked short-selling, meaning such contracts must be based on collateral using shares or other securities.

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