China Tightens Grip on Short Selling to Stabilize Market

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China has implemented stringent measures to restrict short selling and quantitative trading strategies in a bold move to buoy its faltering stock market ahead of a major economic policy meeting. The China Securities Regulatory Commission’s decision to raise margin requirements for short selling and halt securities lending to brokerages aims to counteract a significant market downturn that has erased around $1 trillion from onshore market value since mid-May.

The regulator’s approval for increased margin deposits—effective from July 22—makes short selling more expensive, impacting hedge funds and other investors keen on such strategies. Additionally, China Securities Finance Corp., the main provider of stock lending, will pause its lending operations starting July 11. The quick and decisive actions have already provided a short-term boost, with Chinese stocks rising on Thursday; however, experts suggest that the minimal role of short sellers in China might limit any long-term benefits.

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China, along with South Korea and Thailand, frequently enacts aggressive measures to curb short sales and quantitative trading in a bid to stabilize their markets. Despite these efforts, the underlying issues—housing crisis concerns, renewed trade tensions, and low consumer confidence—remain unresolved, posing ongoing challenges.

“This move signals that regulators are wary of risks tied to the buildup of short positions,” commented Redmond Wong, a market strategist at Saxo Capital Markets. “While it might temporarily lift prices of heavily shorted stocks, the broader market impact is likely to be limited.”

Indeed, the CSI 300 Index experienced a gain of over 1%, potentially ending a streak of weekly losses, while the Hang Seng China Enterprises Index surged as much as 1.6% in Hong Kong. Still, these gains follow months of decline spurred by poor corporate profits, which have seen the CSI 300 relinquish almost all its yearly gains and the MSCI China Index dip into a technical correction.

President Xi Jinping’s impending Third Plenum, set for July 15, has subdued expectations for significant stimulus. Analysts from leading firms like Goldman Sachs and JPMorgan Chase & Co. predict that instead of new major initiatives, existing measures might be expanded.

The new rules specify that investors must put down a margin deposit equivalent to 100% of the value of borrowed securities for short selling—a stark increase from the current minimum of 80%. The margin ratio for private funds involved in stock lending will also rise to 120% from 100%.

“In the short term, these steps will likely prompt the closure of existing short positions and limit new short-selling activities,” said Steven Leung, executive director at UOB Kay Hian Hong Kong. “In the medium term, the market will still be driven by economic fundamentals and corporate earnings.”

The CSRC’s moves reflect a broader trend under Chairman Wu Qing, who has intensified scrutiny of quantitative funds since February, requiring new entrants to report their strategies before trading. Beijing has also widened reporting requirements for offshore investors through mainland-to-Hong Kong trading links.

The regulator emphasizes that bolstered daily supervision and timely adjustments are crucial for market stability. These measures are considered beneficial for risk prevention and the market’s orderly development.

There’s also a consideration to impose additional charges for high-frequency quantitative transactions. Notably, the number of high-frequency trading accounts in China has dropped more than 20% this year to approximately 1,600.

Since the February restrictions, short selling in China has plummeted. Short trades and securities lending plunged by 64% and 75%, respectively, contributing to their minimal share of just 0.05% of the market’s total value. As of the latest data, the outstanding value of securities lending has more than halved since the end of 2023 to 31.8 billion yuan ($4.4 billion).

“Though this may boost sentiment somewhat, it will increase costs and reduce efficiency for long-short strategies, potentially eroding their performance,” noted analysts including Xu Kang in a report.