China Seeks to Bolster Short Selling After Opening of Tech Board

China’s securities regulator has allowed mutual funds to indirectly lend company shares to short sellers in an effort to bolster the underdeveloped practice, which has gained greater flexibility with the creation of the country’s new high-tech board.

The China Securities Regulatory Commission (CSRC) on Friday published guidelines (link in Chinese), dated June 14, that allow mutual fund firms to lend securities to China Securities Finance Corp. Ltd. (CSF), a state-owned intermediary that lends shares that it has either bought or borrowed to brokerages. Brokerages can then lend on these shares to other parties engaged in short selling. Prior to the guidelines, CSF chiefly borrowed stocks from brokerages.

The guidelines specify rules for mutual funds to participate in short selling — a practice in which investors borrow shares from a brokerage and then immediately sell them in hope that the share price will fall in the future. If that happens, the investors can rebuy the stock at a discount, return the borrowed shares and profit from the difference.

Short selling allows investors to bet that share prices will fall, which is useful for the development of the stock market because the practice can keep share prices in check and perhaps head off a market bubble.

In the past, mutual funds in China did not participate in the securities lending business. The business will provide mutual fund firms with a new source of revenue, said a product director at a mutual fund company. “Lending these securities can generate some income,” the director told Caixin.

The change also has an added benefit that it can make more securities available for short sellers to borrow now that the new high-tech board has allowed more flexibility in the practice, the director said. Securities available for borrowing have often been in short supply.

The Shanghai Stock Exchange’s new high-tech board has allowed the shares of companies listed there to be the targets of short selling and to be traded on margin from the first day they are listed. In contrast, shares of companies listed on other boards of the Shanghai (link in Chinese) and Shenzhen (link in Chinese) exchanges can only become such targets after meeting certain requirements three months after they list.

Under the new CSRC guidelines, not all funds are eligible to lend out securities. The guidelines specify several types of qualified funds, including stock funds or funds that invest at least 60% of their money in stocks — provided that the money invested is subject to a lockup period. The CSRC will also allow participation by certain open-ended stock-index funds and other funds that invest in them, as well as closed-end strategic equity funds that participate in companies’ strategic allocations of shares.

China’s stock market has long seen much less short selling than margin trading. As of Monday, the outstanding balance of short selling in the Shanghai and Shenzhen markets was 8.9 billion yuan ($1.3 billion), well below the outstanding balance of margin trading, which stood at 905.1 billion yuan, according to CSF data (link in Chinese).

Contact reporter Timmy Shen (hongmingshen@caixin.com, Twitter: @timmyhmshen)