Thursday, July 9, 2015

The Dangerous New Interventions of Chinese Stock Market Regulators

By Ling Huawei

On Saturday, representatives of 21 securities firms were summoned to the Beijing headquarters of the China Securities Regulatory Commission (CSRC). Soon afterward these companies announced they would use their own capital, some 120 billion yuan, to buy exchange-traded funds linked to blue-chip stocks on the Shenzhen and Shanghai bourses. They also promised not to sell any of their holdings until the benchmark Shanghai Composite Index SHCOMP, +5.76%  recovered to at least 4,500 points.

These are clearly not market-driven decisions. Anyone with common sense knows that 120 billion yuan will not be enough to reverse the market’s fall. And the intervention raises a thorny question: Who takes the blame if the securities firms suffer losses because they had to make investments against their better judgment?

Meanwhile, the regulator needed only two weeks to make a U-turn on investors borrowing money from outside securities firms. The market collapsed essentially because stocks were overvalued and margin trading was excessive. The regulator moved too slowly to bring unsupervised margin trading under control. When it finally acted decisively on June 23 to sever the channels through which investors borrowed money from banks rather than securities firms, the market went into free fall.

Pressure kept mounting from investors who were bound to lose if the slide continued, and the regulator caved. Its recent moves amount to encouraging institutions to continue lending to investors, even though it may amplify the risk it was trying to control.

It wants to stabilize the market by keeping retail investors from dumping their holdings, but it may end up hurting more of them. Investors got burned for believing the government could stop share prices from falling further, and each time they were proved wrong. If they had no such illusions, things might have worked out better.

In a healthy market, investors make independent decisions about whether or not to buy or sell a stock. This is how the market prices the value of shares.

But in the A-share market, government intervention disturbs the price-discovery process because it unifies investor expectations and encourages them to make the same choice.

This means investors no longer care about the true value of a stock. They only wonder when the government will step in and how much extra liquidity will be available. In this scenario, investing becomes gambling on the government’s actions.

The above is an abridged version of an article that originally appeared at Caixin Online. It was translsted by Wang Yuqian.

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