Equities

China Tightens Short Selling, Shanghai Index Up 0.77%

China curbs short selling with new measures as $6 trillion wiped off stock market since 2021 peak.

By Athena Xu

7/11, 09:19 EDT
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Key Takeaway

  • China has introduced stringent measures to curb short selling, including increased margin requirements and halting share loans by China Securities Finance Corp.
  • The Shanghai Composite Index rose 0.77% following the announcement, with tech and healthcare stocks leading gains, while financial stocks fell.
  • Historical data suggests short-selling bans offer limited long-term market support; outstanding securities-lending value has more than halved to 31.8 billion yuan ($4.4 billion).

Stringent Measures to Curb Short Selling

In an effort to support the faltering Chinese stock market, the government has introduced some of the most stringent measures yet to curb short selling. The China Securities Regulatory Commission (CSRC) has approved an increase in margin requirements for short selling, effective from July 22. Additionally, China Securities Finance Corp., the country's largest stock lender, has halted the practice of loaning out shares starting July 11. These measures come after earlier restrictions failed to halt the market's decline, which saw more than $6 trillion wiped off the value of Chinese and Hong Kong stocks from their peak in 2021.

Short selling allows investors to profit from a falling market by borrowing shares, selling them, and then repurchasing them at a lower price. However, if the shares rise, short sellers incur losses. In China, short selling was officially introduced in March 2010, and by 2024, more than 3,000 stocks and exchange-traded products were eligible for short selling. Despite this, brokerages only lend shares to clients with at least 500,000 yuan ($69,500) in funds and no major default record.

Earlier this year, state-controlled Citic Securities stopped lending stocks to individual investors and imposed additional conditions on share loans to institutions. Other brokerages like China Securities Co. and GF Securities Co. banned clients from using margin loans to buy and return stocks they sold short. In October, regulators tightened margin requirements for hedge funds, requiring them to hold 100% of the transaction value in their account. A subsequent order in November compelled brokerages to cap the size of their securities-lending businesses.

Market Reactions and Historical Context

The latest measures have sparked mixed reactions in the market. Following the announcement, the Shanghai Composite Index saw a 0.77% increase, closing at 2,961.99 points. Blue-chip stocks within the CSI 300 Index climbed 0.98%, while Chinese H-shares listed in Hong Kong rose by 1.44%. Tech and healthcare stocks, in particular, soared, with the Healthcare Index gaining 3.07% and the New Energy Stocks Index leading the rally with a 3.8% rise. However, the CSI300 Financial Sector Sub-Index fell by 0.75%.

Historically, clamping down on short selling has rarely provided the market with more than a short-term boost. In a Chinese stocks boom-and-bust cycle in 2015, the government restricted short selling to force out day traders, but the market continued to slide in the following months. Similarly, in South Korea, stocks staged a brief rally after the country reimposed a short-selling ban in November, yet the Kospi Index later erased most of those gains. A study of short-selling bans from 2007 to 2009 found such curbs were detrimental to market liquidity and failed to support asset prices.

"The move sent another signal that the regulators are concerned about the risks to the securities industry given the buildup of short positions that may be concentrated," said Redmond Wong, market strategist at Saxo Capital Markets. "It may prop up the prices of some stocks that have a large short interest and are difficult to find to borrow. For the broader market, the impact is likely to be limited."

Broader Implications and Future Measures

The CSRC's latest moves align with other steps taken by the regulator since Wu Qing became its chairman. In February, officials said quant funds would be scrutinized, and new entrants would have to report their strategies to regulators before trading. Beijing has also expanded the scope of reporting of offshore investors via a mainland-to-Hong Kong trading link. The market is in need of strengthened daily supervision and other adjustment measures in a timely manner, the regulator said. The changes are "beneficial to preventing risks and safeguarding the market’s stable and orderly development," it added.

While the regulator is now also considering charges for additional traffic in high-frequency quantitative transactions, it noted that the number of high-frequency trading (HFT) accounts in China has dropped more than 20% so far this year to some 1,600. Short-selling in China had already drastically declined in the wake of the February measures, when the lending of some shares was banned. The outstanding amount of short trades and securities lending plunged by 64% and 75%, respectively, from August 2023, according to the regulator.

Short trades account for just 0.05% of the market’s total value, the CSRC said. The outstanding securities-lending value has more than halved since the end of 2023 to 31.8 billion yuan ($4.4 billion) as of Tuesday, according to Bloomberg-compiled data. Of those, 29.6 billion yuan has been through stocks provided by China Securities Finance Corp., according to Huachuang Securities.