China to Allow Short Selling on Trial Basis

2008-10-5

China to Allow Short Selling on Trial Basis

Quoted from WSJ

China’s securities regulator said Sunday it would shortly begin a trial program allowing securities firms to engage in margin lending and short selling, long considered necessary to help the country’s stock market mature beyond its repeated boom-bust cycles.

The China Securities Regulatory Commission said in a statement on its Web site that the program would be started, but it didn’t give a timeline. It said that the brokerages allowed to participate in the program would be decided based on their net capital size and risk capabilities, among other criteria. The trial would be expanded at some point, it said.

Margin trading allows investors to borrow money to buy shares. Short selling allows investors to sell borrowed stocks, typically in a bet that prices will fall.

The introduction of a tool like short selling runs counter to the trend in many markets in the U.S., Europe and other parts of Asia, where regulators have limited the practice. Some companies have blamed short selling for contributing to the lack of confidence that has driven the credit crisis and forced many financial companies to find suitors, seek more capital or file for bankruptcy protection. It is unclear why Chinese regulators are acting now, but the move suggests that the world’s credit crisis hasn’t derailed some of their basic plans to reform.

The decision also suggests Beijing’s policy makers believe a recent effort to boost the market put a floor under the prices of key stocks and lessened the risk that short-sellers might weigh heavily on prices. The government last month pledged that state agencies would buy stock in major listed banks and companies. Officials may have delayed the introduction of short selling during last year’s market rally on concern it could raise the likelihood of a crash.

China’s market structure currently permits investors little leeway to protect themselves from the possibility of a market fall. Local market analysts have said short selling and other hedging measures would give investors another way to prepare for a falling market. Currently, the only option is to sell and walk away.

The Chinese stock market has endured two major boom-bust cycles in about a decade, with the Shanghai Composite Index falling as much as 60% this year before staging a modest bounce in recent weeks. The existence of products permitting investors to bet on a market fall, proponents of such products say, would have taken some of the steam out of the market as it was rising.

The Shanghai index, which was closed last week due to a national holiday, finished Sept. 26 at 2293.78, down 16% for the third quarter, its fourth straight quarterly drop. The market is down 56% since the beginning of the year.

Sunday’s announcement suggests a modest introduction aimed at select brokers, not a new product for the mass of retail investors who do most of the trading on China’s markets. The announcement also made no mention of the possibility of the introduction of stock index futures, a product that is also used for hedging against risks that has been discussed by regulators repeatedly in recent years.

Traders and analysts in recent weeks have speculated that China would likely allow margin lending and short selling soon. Shares of some listed brokerages have risen on hopes that the new businesses would improve their fee income. Brokers’ stocks have also been helped as China’s markets have rebounded from their September lows following news that Chinese government agencies would buy shares of listed companies on the open market.

In August 2006, China’s two stock exchanges issued rules on margin lending and short selling, stipulating the maturity and size of the margins and the stocks in which margin trading and short selling would be allowed. But regulators delayed approving securities firms for margin trades because of concern the new business would add to market turbulence.

Write to J.R. Wu at jr.wu@dowjones.com and James T. Areddy at james.areddy@wsj.com