China’s stock market has faced significant turbulence recently, and amid its attempts to bounce back, the nation’s regulators are launching investigations into hedge funds and brokerages. They are particularly interested in the quantitative trading strategies these entities employ. Such strategies, which leverage rapid trading using data-driven computer models and derivatives, have the potential to profit from fluctuations in share prices and market instability.
Context of the Probe
The China Securities Regulatory Commission (CSRC) has recently engaged with multiple prominent brokerage firms. Their inquiries center around short-selling activities and the trading tactics used by their quantitative clients, inform insiders knowledgeable about the investigations.
In a parallel move, the Shanghai and Shenzhen stock exchanges, following the CSRC’s lead, have been gathering information from leading quant funds. These exchanges are eager to understand the methodologies these funds employ to generate profits.
One source elaborated on the regulators’ interests, stating they are keen to know the “logic of the trading, the profit source, when net long or net short positions are held, and the rationale behind purchasing and selling decisions.”
Although these sources opted to remain anonymous due to their inability to officially speak to the media, both stock exchanges, when approached by Reuters for comments, negated the descriptions of the ongoing investigations. The CSRC, meanwhile, did not offer any comments.
Scope and Global Impact
Global quant fund giants, like Winton and Two Sigma, have a presence in China. At this stage, it remains uncertain if these international entities are part of the ongoing scrutiny.
The Larger Picture
This new regulatory scrutiny follows a series of measures intended to benefit the market. Despite these efforts, including reducing stamp duty, the market is yet to witness a stable rally. Current figures indicate that it’s down by approximately 5% since the beginning of the year.
This market underperformance has led to a surge in criticism, especially on social media platforms. Fund managers and regular investors have directed their frustrations towards quant funds and those engaged in short-selling.
Earlier in the month, the CSRC declared its intention to enhance its oversight over program trading. This has raised concerns among market participants, with many speculating the possibility of more stringent regulations on short-selling and specific financing operations by hedge funds.
It’s worth noting that this isn’t the first time China’s regulators have taken such an interest. During the 2015 market crash, they nearly halted operations in the index futures market, pointing fingers at shortsellers for the chaos.
Quant Funds in Focus
As of the end of 2021, quantitative funds in China amounted to more than 1.08 trillion yuan ($147.94 billion). This marks a near doubling in value compared to the previous year. Prominent players in China’s quant fund scene include High-Flyer Quant Investment, Yanfu Investments LLC, and Shanghai Minghong Investment Management Co.
Some insiders believe that a deeper comprehension of the diverse quant strategies might prompt regulators to restrict those contributing to market swings. Quant funds’ short-selling activities might also be under scrutiny.
Yuan Yuwei, a fund manager at Water Wisdom Asset Management, shed light on the situation by highlighting the willingness of brokerages in China to lend securities to quant funds for short-selling. He commented on the potential unfairness of this system as many in the market lack access to such securities lending.
While investigations are ongoing, there haven’t been any definitive conclusions drawn so far.
Issues of Leverage
Apart from the aforementioned points, regulators have also shown interest in Direct Market Access (DMA) data. Through DMA, Chinese hedge funds can secure loans from brokerages to support their leveraged bets, needing a deposit of only 25 cents for every dollar borrowed.
A source from a brokerage mentioned the high leverage of DMA, which can enable quant funds to amass significant profits. Another stated that the CSRC sought clarity on the scale of their quant clientele and any potential impact their trading might have had on the stock market.
An Argument for Tighter Regulations
Yang Tingwu, vice general manager of asset manager Tongheng Investment, advocates for more stringent regulations for quant funds. He suggests that many Chinese quant funds place profitable bets on ill-managed companies based solely on momentum cues rather than actual company fundamentals. In his words, while the quant strategy is essentially neutral, “in China, it’s being used to provide liquidity to the bad guys,” hinting at publicly traded companies with subpar governance.
Conclusion
China’s regulators, in light of the stock market’s struggles, are actively engaging in investigations to ensure transparency and stability. The focus on quantitative trading and the practices of hedge funds signal a move towards more robust regulatory frameworks in the future.
Read More: