CSRC At Its Best
Managers of Government-run Chinese mutual funds keep coming up with the same can’t-miss moneymaking opportunity for Lin Rongshi–and for themselves. The messenger might be a low-level functionary or a trusted middleman. Lin, a private fund manager, said the message sometimes would be delivered in his high-rise office overlooking Shanghai’s financial district or, more discreetly, by mobile phone. “They notify us first, and they would buy a few days later [for the fund], then they would come back to us to split the profit I make from buying at a lower price,” says Lin.
This front-running scheme would net an almost guaranteed haul for Lin and for the state-sector employees. Some others, –insiders all, would profit, too. The only outsiders in the transaction would be the mutual funds’ customers, average Chinese investors who have little idea how routinely their money is abused on the Shanghai and Shenzhen stock exchanges. They come to this man to cheat a fortune from the stock market because he was once an expert at it.
Lin says he made his first $100,000 from a trade made on inside information ten years ago, at age 23. He clocked close to a million dollars by the time he was 25, on insider trading, front-running and stock manipulation in the last Chinese bull market, before losing it all and more in 2001 on his last and biggest play.
Rich shareholders, fund managers, even the top management of listed companies–all have approached Lin in the last year, he says. Chinese investors often suspect manipulation behind the sudden, sharp rises in share prices, but their typical reaction is not outrage. Few stock cheaters get caught, and those who do are rarely jailed. The regulator, the CSRC, China Securities Regulatory Commision, is lacking in staff to hunt down cheats, lacking in legal power to punish them severely and sometimes lacking in political clout to take on some of the well-connected state-owned companies it is supposed to watch. Lawsuits are even less effective. The Communist Party, wary of any organized group of malcontents, essentially does not permit class actions.
So, how do you short Chinese stocks when shorting the Chinese mainland market is not allowed? There are several work-arounds, but none are perfect:
- Go through one of China’s Qualified Foreign Institutional Investors. QFII’s—including Citigroup, Goldman Sachs, JP Morgan, Merrill Lynch, HSBC, UBS and several dozen others—are allowed to buy A shares on the Shanghai and Shenzhen exchanges, the playground of domestic Chinese investors. A QFII can offer investors short positions through derivatives. The downside: More middlemen means more transaction costs.
- Short-sell exchange-traded funds that are comprised of Shanghai and Shenzhen A shares. The WISE CSI 300 China Tracker and the iShares FTSE/Xinhua A50 China Tracker are both listed in Hong Kong. The downside: You can’t bet against individual stocks.
- Short-sell a QFII’s closed-end A share fund, like Morgan Stanley’s China A Share Fund. The downside: Even if the value of the fund’s assets falls, that doesn’t mean the fund’s share price also has to fall.
- Bet against Chinese companies listed in Hong Kong. Direxion offers a China Bear 2X Fund and ProFunds Group offers ProShares UltraShort FTSE Xinhua China 25, both betting against the same 25 Hong Kong-traded stocks. If you’re betting on an all-China slump, these funds will rise 2% for every 1% that the 25-company index falls. The downside: Valuations on the Hong Kong “H share” market are not as sky high as on the A share market.
- Wait until China opens its own futures market, which has been expected for some time. The downside: You might miss your chance while you’re waiting. China might not want people betting against their stocks until at least after the Beijing Olympics.
