Views on improving the integrity of global capital markets
25 February 2015

Insider Trading: Is China Serious about Cleaning Up Its Capital Market?

This is the first in a series of blog posts that brings together viewpoints from China and India on financial market integrity in these giant emerging economies, one issue at a time.

China’s high-profile crackdown against corruption has nabbed senior government officials over the past several months. Recent moves by Chinese financial regulators suggest that it is also cleaning up its capital market. In January, the China Securities Regulatory Commission (CSRC) for the first time took punitive action against securities firms for leveraged trading. The regulator suspended Citic Securities, Guotai Junan Securities, and Haitong Securities from opening new margin-trading accounts for three months for allegedly rolling over margin-trading contracts for a large number of investors beyond the legal limit.

This was followed by sanctions against five fund management firms for lack of internal controls leading to insider trading. Only two of these firms were named publicly: China Asset Management, one of China’s largest asset managers, and HFT Investment Management. The latter is a joint venture between Haitong Securities and BNP Paribas Investment Partners BE Holding. The five companies were suspended from issuing new mutual fund products for three to six months.

More shockwaves hit the industry when the president of China Minsheng Banking Corp., one of China’s top 10 banks in terms of market capitalization, resigned and reportedly was taken away by the party’s top disciplinary body to assist in an investigation into a former aide to former president Hu Jintao.

The financial sector crackdown is noteworthy because it implicated big names in the industry and the impact on the capital market and, therefore, has been significantly felt.

Shares of Citic and Haitong fell 10% and triggered the daily price fluctuation limit mechanism on the Shanghai Stock Exchange following the news. In Hong Kong, where there is no fluctuation limit, Citic’s price plunged 14%, while those of Haitong and Guotai dropped 11.8% and 6.5%, respectively.

Signs of greater scrutiny started to emerge in 2013, when regulators investigated alleged profit skimming and insider dealing among bond fund managers. In 2014, the investigative focus appeared to switch toward insider trading on the equity market.

So far, the punishment appears relatively light. Certainly it would seem miniscule compared to the hundreds of millions of fines against erring firms that we see in the West. Are regulators merely going through the motion and paying due respect to President Xi Jinping’s anti-graft campaign?

We believe not.

One, given the inter-locking relationship between the state, the party, and the judicial system in China, regulatory enforcement can be a nuanced balancing of various interests, paramount of all the state’s and the party’s. Unless the wrongdoings have adverse systemic impact on capital market integrity, regulators would likely favor softer approaches. But what may appear as a light touch to outsiders already speaks volumes of the government’s intentions.

Two, the public naming and shaming of firms has great reputational impact as evidenced by the sharp drop in the stocks of these firms. Reputation and trust are everything in the capital market, even more so in China.

Three, thorough investigation into market fraud and insider trading cases takes up a lot of manpower, time, and effort. For suspicious cases, it is cheaper to dish out verbal warnings, which the CSRC has done recently to six other companies, according to the commission’s spokesman Zhang Xiaojun. The implicit message is: “Behave yourself or you are next!”

Last but not least, the crackdown is happening amid an explosive growth in Internet financing, led by the likes of Tencent and Alibaba. This is by no means coincidental and epitomizes the massive market reforms underway. Regulators are sending a stern warning to all banks and other state-owned enterprises that if they don’t follow the rules, no one entity is too big to be replaced by emerging players. (My recent blog post “Are Tencent, Alibaba Innovators or a New Cog in the Chinese Regime?” discusses the rise of these Internet finance giants and their strategic roles within the Chinese capital market reform blueprint.)

So while the capital market crackdown may appear superficial to outsiders, trust that Chinese authorities know what they are doing.

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Photo credit: Churchill

About the Author(s)
Alan Lok, CFA

Alan Lok, CFA, was a director of capital markets policy at CFA Institute. He was responsible for conducting research projects in the area of market instruments and market structures in the Asia-Pacific region. Mr. Lok worked with regulators, institutional investors, academics, and various other stakeholders within the financial industry to uphold investor protection and market integrity.

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