That calm Chinese stock market? It’s engineered by the state
This hidden hand is about to affect a larger number of overseas investors as Chinese stocks are added to a global index
Long derided as a casino, China’s oncevolatile stock market is going through a long stretch of calm. One reason is an orchestrated government effort to keep traders and investors in line.
Three years after a national uproar when Chinese stocks plunged by nearly half in just over two months, traders and brokers say regulators are increasingly stepping in to influence trades and make China's markets appear less volatile, especially during political events when Beijing wants to project stability.
The steps, aided by advanced surveillance techniques to monitor traders, include warning brokerage firms to police trades that are out of step with government wishes and phoning investors directly when they act out of line.
The intervention is becoming more common just when Chinese equities are included for the first time in a global stock index. MSCI Inc., whose benchmarks many investment funds follow, added more than 200 Chinese stocks to its emerging-markets index on June 1. The introduction means more foreign investors will be exposed to a Chinese market that doesn't move purely to the dictates of supply and demand.
"Never in over 25 years of watching the Chinese markets has the state been so involved and interfering in micro issues," said Fraser Howie, an independent analyst and author of "Privatizing China: Inside China's Stock Markets."
Lin Yunan, an investor in the southern city of Shantou, said he received a government warning from his broker in March when he sold and then quickly bought back around $325,000 worth of stock in a department-store operator, during the time of a major meeting of Chinese political leaders.
The broker told him his transactions were deemed too disruptive by the Shenzhen Stock Exchange, which wanted stable markets at a politically sensitive time, according to Mr. Lin. He had to promise to refrain from such behavior in the future to avoid harsher punishment, such as a trading ban.
"The word from the exchange was that my trades were too large and too frequent, and I was told it was all because of the National People's Congress," Mr. Lin said, referring to China's most important annual legislative meeting.
The Shenzhen Stock Exchange and China's securities regulator, the China Securities Regulatory Commission, didn't respond to requests for comment. China's other main equities market, the Shanghai Stock Exchange, declined to comment.
Interventions appear to have contributed to the unusually stable Chinese market over the past two years, though other factors, including a stretch of global calm in 2017 and a relatively healthy economy, likely also played a role. The Shanghai market moved more than 1% on 12 out of 244 trading days in 2017, down from 65 times in 2016 and 141 times in 2015.
In the weeks leading up to and during last October's Communist Party Congress, when brokerage firms and traders say interventions were especially common, Shanghai's benchmark index moved an average of 0.2% daily. The 30 trading days until Oct. 26 were the least volatile such period since the Shanghai exchange opened in the early 1990s, according to a FactSet analysis of exchange data.
Market interventions can create serious problems, including for foreign investors, who have gradually increased their holdings in China since it rolled out "stock connect" programs in late 2014 allowing outsiders to buy and sell mainland shares through Hong Kong.
Such moves by regulators can distort asset prices, making it harder to ascertain stocks' real value. They can reduce the opportunity to make quick profits and make it harder to exit trades at the right time. Over the long haul, those issues can make a market less attractive, hurting returns. More fundamentally, they go against a basic expectation that markets operate freely.
Traders say Chinese government interventions have already contributed to a sharp reduction in market liquidity since 2015, although uncertainties tied to a possible trade war likely also bear some blame. Chinese markets are down 6.4% this year.
"If I can't buy and sell whenever I want, that's the most optically clear and cogent argument that it's not a well-functioning market," said Timothy Atwill, head of investment strategy at Parametric Portfolio Associates , a Seattle-based unit of Eaton Vance Corp. Mr. Atwill said he underweights China because of a lack of investor protections.
Gong Xiaotao, a manager at Shanghaibased private-equity firm Yixinweiye Fund, said his fund has been phasing out of some Chinese positions and investing more heavily in Vietnamese stocks, partly out of concerns over trading freedom in China. On multiple occasions since mid2016, he said, Chinese exchanges have sent text messages to his firm's chairman warning of excessive selling when the fund dumped millions of shares in a particular stock.
Yixinweiye didn't respond to a request for comment.
MSCI has said its decision to include China-listed stocks in its emerging-markets index, after years of rejecting such a move, was primarily the result of China's efforts to improve market accessibility. The move won broad support from international institutional investors. Right now, foreign investors own 2% of Chinese shares.
China's efforts to manage market outcomes are made easier by advances in monitoring techniques that let regulators track trading and fund flows in individual accounts in real time.
On the sidelines of the annual legislative meetings in March, Jiang Yang, vice chairman of the China Securities Regulatory Commission, said the regulator has spent years developing "penetrative supervision" of market participants, creating a "giant network of surveillance" that he said helps protect retail investors.
U.S. stock exchanges can detect unusual trading activity at the brokerage level in real time, but exchanges and regulators in the U.S. can't see live client information. The Securities and Exchange Commission can request and obtain investor account information after identifying suspicious trades. A yearslong effort to access real-time customer trading data has been strongly opposed by the financial industry, said Michael Friedman, chief compliance officer at Trillium Management LLC, an electronic trading and technology firm in New York.
During the Communist Party Congress in October, a client of Haitong Securities Co. had its trading account temporarily frozen by the Shanghai exchange after selling more than $1 million worth of stock in one of China's biggest banks, said a person familiar with the incident. The Shanghai exchange barred the client, a private-equity firm, from trading other securities for a day, the person said.
There aren't clear yardsticks for the size of trades that can trigger calls from authorities, though several brokerage executives said trades of between one million and two million yuan-roughly $155,000 to $310,000usually attract scrutiny.
During some recent bouts of market volatility, regulators stayed on the sidelines, possibly because they blamed the volatility on global developments rather than Chinese domestic matters. Traders say they assume Beijing will intervene if any selloff starts to get out of control.
Beijing has had a complicated relationship with its stock markets ever since it allowed Shanghai to open its exchange in 1990. Then-leader Deng Xiaoping wanted to adopt some tools of Western capitalism, but he also warned that if the stock market "turns out to be a mistake, we'll just shut it down."
The market rose an average of 24% a year from its inception to 2017 and helped to capitalize dozens of state-owned enterprises. The value of companies listed on the Shanghai and Shenzhen exchanges now totals about $8.5 trillion.
Regulators at times limited the number of initial public offerings and used statebacked funds to boost shares of stateowned companies. They sometimes provided informal guidance, such as via state media, to investors on how to behave.
None of that prepared traders for what came in June 2015. A stock rally encouraged by the government turned to a disaster when investors grew nervous about the frenzy and suddenly rushed for the exits. To combat the plunge, Beijing temporarily banned betting on stocks to fall, halted IPOs, curbed trading with borrowed money and froze dozens of trading accounts. One fund manager went to prison for stock manipulation. Authorities set up a "national team" through which state-backed investors were called on to support the market by buying shares.
The steps stabilized the market, but after another swoon, Beijing named a new chief regulator, and traders began noticing more aggressive interventions involving
individual trades.
Before the October start of the Communist Party Congress, an event held every five years, the new securities regulator, Liu Shiyu, urged domestic brokerage firms to recognize the importance of preserving market stability "at the level of political consciousness."
On the day the Congress opened, a local branch of Shanghai-based Shenwan Hongyuan Securities Co. received an urgent notice from the firm's compliance department. The department asked the branch to issue immediate warnings to three clients who had placed sell orders of up to two million yuan, according to a notice reviewed by The Wall Street Journal.
Shenwan issued such warnings to its branches nearly every day during the weeklong Congress, said an executive of the firm. Citing regulators' instruction to "prevent sharp market volatility," Shenwan's compliance department said in the notices that the required warnings were meant to "guide clients toward rational and normal trading behavior."
A representative of Shenwan declined to comment.
"It's counterintuitive to imagine that brokerages would impose such restrictions on their own clients because by right the more trades are done, the more money they earn," said Shen Meng, the director at Chanson & Co., a boutique investment bank in Beijing. "This just tells you how the pressure on preserving market stability actually builds up from the very top to the bottom."
Daily trading volume in Shanghai has recently shrunk to below 200 billion yuan, from above 300 billion yuan in mid-January and a record 1.3 trillion yuan just before the 2015 summer rout.
Mr. Lin, the investor who drew a warning for selling and then buying back department-store shares, said he will no longer attempt short-term trades because of regulators' interventions.
He understands they may want to keep markets more orderly, especially ahead of the MSCI index inclusion. "But there's an old saying in Chinese," Mr. Lin said: "When the water is too clean, no fish can live in it."