China Introduces Restrictions on Short Selling
In light of the turbulence in China’s stock market in the past few months, Chinese regulators have introduced a series of measures with a view to stabilizing the stock market. One of the measures is to suspend short selling activities through securities lending, in addition to a slowdown of A share IPOs.
Under the previous regime, A shares with or without lock-up restrictions are permitted to be used for securities lending. As a result of such flexibility, this effectively became a back door (or regulatory loophole) for certain investors to liquidate their A shares that are subject to lock-up restrictions via securities lending, as they would not be otherwise permitted to directly sell such A shares in the secondary market. A significant number of A shares with lock-up restrictions were effectively “sold” through this arrangement and the ordinary investors of these listed companies have been adversely affected by the declining share prices. Some investors have blamed the market turbulence on certain shareholders who have effectively cashed out by way of securities lending.
The restrictions imposed by the CSRC in October 2023 started with the suspension of lending of A shares placed, as part of an IPO, to strategic investors and asset management plans which are established for the senior management and key employees of listed companies (i.e. these shares cannot be used for securities lending). In January 2024, the suspension was expanded to all A shares with lock-up restrictions, and the lock-up period for these A shares usually ranges from one year to three years, or even longer in certain circumstances. The overall suspension became effective on 29 January, 2024. This means that pre-IPO investors will have limited channels to cash out their holdings in A share listed companies during the lock-up period. Seeking financing through pledging the lock-up A shares seems to be the only remaining option for these investors, but due to the restricted nature of such A shares, lenders will likely apply a heavy discount.
Another measure announced by the CSRC is to introduce a waiting period for trading of securities lent from “T+0” to “T+1”. Any securities financing firm that borrows A shares from investors will now need to wait one trading day before on-lending them to securities brokers. Previously, these shares were immediately made available to brokers so they can be quickly traded in the secondary market. This new measure will become effective on 18 March, 2024.
In addition, the CSRC imposed stricter capital requirement for securities lending and margin financing activities. Effective from 30 October, 2023, the minimum margin ratio for investors in connection with securities lending and margin financing was lifted from 50% to 80%. For privately-offered securities investment funds, they are now subject to a margin ratio of 100%. As a result, the cost for securities lending and margin financing activities will likely be higher than before.
All these measures are intended to limit regulatory arbitrage. In particular, it is expected that the suspensions of securities lending of restricted A shares would further reduce the total amount of A shares that are available for margin trading in the market. However, whether these will help to stabilize the market is yet to be seen.
