Outright ban on securities refinancing not best solution

The China Securities Regulatory Commission has announced a halt to securities refinancing starting Thursday, in the latest move to maintain stock market stability. Existing contracts can be extended, but they must be settled no later than Sept 30, the CSRC said on Wednesday.

The persistent market volatility in the A-share market, despite continuous positive indicators, can be attributed to several key factors.

First, the current favorable news mostly pertains to long-term institutional improvements, with limited immediate impact on the market. Policies such as enhancing the quality of listed companies, promoting dividend increases, and managing the market value of central enterprises are expected to take three to five years to show substantial effects. These measures, while positive, do not offer immediate support to current market trends.

Meanwhile, the ongoing global macroeconomic slump, coupled with changes in Chinese government policies, has contributed to market fluctuations. The macroeconomic environment is one of the primary factors influencing stock market trends. Recent Chinese economic data and policy support have indeed brought positive signals to the market. However, global economic uncertainties and international trade relations also contribute to market volatility.

Moreover, market sentiment and investor behavior shifts can also lead to market turbulence. Positive news may initially drive the market upward, but subsequent profit-taking behaviors can trigger volatility.

One of the main roles of the securities refinancing mechanism, which enables major shareholders of listed companies to lend shares they own to investors, is to increase market liquidity, facilitating easier buying and selling of securities. This should theoretically aid in price discovery and market stability. However, there are potential issues in practice.

To start with, it leaves room for short-term volatility and short-selling. After positive news, the market typically experiences an upswing. However, as stock prices rise, some investors might use the securities refinancing mechanism to short-sell, anticipating a short-term market correction. This behavior can exacerbate short-term volatility, leading to market fluctuations.

Second, it will amplify the influence of large funds. The securities refinancing mechanism allows large funds and institutional investors to operate more flexibly. They might engage in hedging, buying stocks to benefit from an uptrend while short-selling to mitigate risks. Such complex operations could introduce certain volatility effects into the market.

Despite issues with the securities refinancing mechanism, an outright ban is not the best solution.

First, the securities refinancing mechanism plays a positive role in increasing market liquidity and providing risk-hedging tools. Second, completely banning the securities refinancing mechanism could reduce market liquidity, affecting price discovery and market efficiency.

More importantly, banning the securities refinancing mechanism will not fundamentally resolve issues like market manipulation and unfair competition, which require improved regulatory frameworks and market mechanisms.

To mitigate the negative impact of the securities refinancing mechanism on market trends, further regulation is necessary.

First of all, more efforts are needed to enhance information disclosure. Real-time disclosure of trading data is essential. This includes requiring securities firms and fund management companies to disclose the frequency and scale of their securities refinancing transactions, including the quantity, price, and counterparties for each transaction.

Regular disclosure of the holding of large funds and institutional investors that conduct securities refinancing transactions routinely, particularly large and concentrated holdings, should occur monthly or quarterly. Clear disclosure of the purposes of borrowed securities, especially for large-scale short-selling operations, is crucial.

Additionally, compliance audits should be strengthened by introducing third-party independent audit institutions to ensure the authenticity and completeness of disclosures. Noncompliant institutions should face strict penalties, including fines and business suspensions.

Meanwhile, there is a need to limit short-selling ratios. Set dynamic short-selling ratio caps, adjusting based on market volatility. For example, during high volatility, limit short-selling ratios for individual stocks to within 10 percent of their free-float shares, and relax this to 15-20 percent during stable periods.

Moreover, efforts are needed to implement stricter caps for strategically important industries or stocks to prevent malicious short-selling from threatening national economic security.

Additionally, there is a call for introducing a tiered management system based on the scale, historical performance, and risk management capabilities of institutions, allowing larger, well-performing institutions higher short-selling caps while imposing stricter limits on smaller and new entrants. Regular evaluations should adjust caps dynamically based on performance and market conditions.

Finally, more measures are needed to actively regulate arbitrage behavior, such as establishing a real-time monitoring system to track large funds and institutional investors that conduct securities refinancing transactions routinely. Under the system, such behavior would trigger early warning mechanisms for unusual activities like frequent large-scale borrowing and repayment.

Use big data and artificial intelligence to analyze trading behavior deeply, identifying potential arbitrage. Introduce trading restrictions, such as requiring borrowed securities to be held for a minimum period (such as 10 trading days) before closing positions, to prevent rapid arbitrage operations.

Temporarily increase securities refinancing borrowing rates in specific market conditions (for instance, when a share price fluctuation exceeds a limit) to reduce arbitrage incentives. Enhance regulatory cooperation between securities regulators and other financial oversight bodies to jointly tackle cross-market and cross-product arbitrage, sharing information and experiences with international counterparts to address cross-border arbitrage.

The writer is a professor of finance at the University of International Business and Economics.

The views don't necessarily reflect those of China Daily.