Chinese short-selling will be no bear’s picnic

January 25, 2010

Hedge funds watching China’s markets are licking their lips at what they see as the best shorting opportunity since Enron. But while plans to allow short-selling are imminent, this won’t be a bear’s picnic. Beijing’s plans to allow two-way equity bets will give foreigners little chance. Borrowing individual stocks will be tricky, even for locals.

After many countries such as the United States and UK put more severe restrictions on short-selling, China is taking the contrarian view. The short-selling regime has been three years in the making. The goal is to allow investors to express a different view on the market, and prevent market valuations getting overly stretched.

For now, foreigners are not invited. They can only short the broad market though index futures, not individual stocks. Foreigners now own up to $15 billion of China stocks through the qualified foreign institutional investor scheme. Their shorting quota is unlikely to exceed 10 percent, or $1.5 billion — just 5 percent of the daily turnover.

But even locals won’t get much of a look-in. Brokerage firms will only be able to lend out stocks that they own, unlike other markets where short-sellers can borrow from pension funds, insurance companies, and custodian banks. Chinese insurance companies, who buy and sell at a rapid rate, are unlikely to lend stocks out for a long period anyway.

Even limited short-selling may sound better than none. Except the market regulators are also making it easier for stocks to go up, by enabling trading on margin. Investors can soon buy index futures with just a 12 percent cash outlay, and borrow the rest. Chinese mutual funds look stretched now with 84 percent of their money already invested into stocks, which is a record. Margin trading will give them more firepower.

China always likes to cross the water by feeling the stones. Since the idea of short-selling is a political hot potato, and many of the stocks listed in China have substantial state ownership, fear of bears running rampant is understandable. That is a shame: with the Shanghai index trading at half its 2007 peak, now would have been a good time for bolder changes.

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