The Irony Of Market Manipulation

Having gazed ominously at the extreme monetary policy smoke-and-mirrors intervention in bond markets, and previously explained that "the stock market is to important to leave to the vagaries of an actual market." While the rest of the world's central banks' direct (BoJ) and indirect (Fed, ECB) manipulation of equity markets, nobody bats an eyelid; but when PBOC steps on market volatility's throat (like a bull in a China bear store), people start complaining... finally. There is no difference - none! And no lesser Asian expert than Stephen Roach warns that we should be afraid, very afraid as he states, the great irony of manipulation, he explains, is that "the more we depend on markets, the less we trust them."

 

BoJ is directly buying Japanese Stocks and the rest of the world's central banks are buying bonds with both hands and feet... for the first time ever, central banks are set to monetize all global government debt, something we showed previously...

 

But with China's heavy handed "measures" seemed to save the world (until the last 2 days)...

9-Jul-15 Thurs CSRC:
1) suspended reviews of IPOs & other secondary market fundraising activities from Jul 9;
2) asked listcos to choose 1 out of 5 measures (including share buyback by major shareholders, companies and senior executives, employee stock buyback
incentive & employee stock ownership) to protect share price.
China Banking Regulatory Commission (CBRC):
1) allowed banks to roll over matured loans pledged by stocks;
2) encouraged banks to provide liquidity to China Securities Finance Corp Ltd. (CSFC) & offer financing to listed companies to buy back shares.
China Insurance Regulatory Commission (CIRC): insurance asset mgt companies should not demand early repayment from brokers for debt products on margin financing.
Minister of Public Security & CSRC: to investigate malicious short selling activities on Jul 9.
State-Owned Assets Supervision & Admin Commission (SASAC): asked provincial SASACs to submit daily report if local SOEs’ increased stock holdings starting Jul 9.
CSFC: issued Rmb80bn short-term note in interbank market on Jul 9, yield at 4.5% p.a., duration at 3 months; and will purchase mutual fund products to stabilize liquidity.

8-Jul-15 Weds PBOC: vowed to maintain market stability and avoid systematic financial risk. It will provide ample liquidity to CSFC via interbank lending, financial bond, pledge financing, and relending facilities.
CSFC
1) granted Rmb260bn credit quota to 21 brokers via pledged stocks to allow them buy more equities.
2) by people close, CSFC is looking for >=Rmb500bn liquidity support from the PBOC.
3) CSFC Chairman said it has sufficient liquidity to stabilize the market.
4) CSFC to subscribe Rmb200bn active funds from 5 mutual funds to invest in smid cap stocks.
5) CSFC to intensify efforts to buy small to mid-cap stocks.
SASAC & MOF ordered central-owned SOEs and financial companies not to cut existing equity holdings and all central owned SOEs soon echoed with SASAC’ instruction.
Huijin vows not to reduce existing securities holdings and will continue to buy ETFs.

7-Jul-15 Tues CIRC: to allow insurers to invest more in blue chips stocks: 1) investment in a single blue chip will be capped at 10% of the insurers’ total assets as of last quarter, vs. the previous 5%; 2) equity investment will be capped at 40%, vs. 30%, but the 10% difference must be invested in blue chips. CSFC said it will buy more smid-cap stocks Several joint stock banks resumed funding to umbrella trust; but have lowered leverage to 1x vs previous 3x.

6-Jul-15 Mon CFFEX took more measures to restrict index future trading by 1) capping the number of withdrawal of a single contract to 500/account/day; 2) raising margin for selling index futures of CSI500 from Jul 8 to 20% of contract price from 10% and up to 30% from Jul 9. CSFC to use Rmb120bn funds contributed by various brokers to buy ETFs. Social Securities Fund (SSF) vowed not to reduce existing equity positions in its portfolio.

3 to 5-Jul-15 Fri-Sun Huijin purchased Rmb12bn ETFs

  • Margin financing: some brokers lowered threshold and loosened related policy.
  • Short selling: 1) several brokers suspended the business; 2) multiple unauthorized margin financing institutions said their total funding size was no more than Rmb200bn, and denied their involvement in short selling.
  • Index futures: 1) CFFEX suspended many shorting accounts; 2) will make transaction fees progressive based on transaction volume; bigger volume, higher fee rate.
  • Capital market fundraising: 1) State Council decided to suspend IPO and any secondary market fundraising above Rmb5bn until SHCOMP returns to 4,500 level; 2) CIRC required insurers to keep net buying stocks; 3) 21 brokers will invest Rmb120bn (15% of their net assets by 1H15) in blue chips ETFs and would not reduce their proprietary book if SHCOMP stays below 4,500; 4) 94 mutual fund management companies vowed to stabilize the market.
  • Disciplines: 1) Police is investigating three media outlets for spreading rumors; 2) the government vows to impose heavy penalties on cross-market manipulation activities. Government mouthpiece: Xinhua and People’s Daily both published articles today to call for investors’ confidence.

2-Jul-15 Thurs CSRC said to investigate and “strictly” punish manipulations; Bloomberg reported CSRC has conducted examination on recent stock index future short selling activities. Brokers: some brokers loosened margin financing requirements eg cut margin ratio; extend margin financing duration period; raise collaterals discount ratio etc. Insurers have been buying blue chips stocks and ETFs since last Friday; though pace has moderated somewhat on Jul 2. Media reported that many mutual funds and privately raised funds also increased equity holdings.

1-Jul-15 Weds Shanghai Stock Exchange (SHEX), Shenzhen Stock Exchange (SZEX) & CSDC will cut transaction fees by 30% effective on Aug 1. CSRC granted brokers new financing channels, including: 1) All brokers, not limited to the trial 20 ones, can issue short-term bonds; 2) brokers can securitize their beneficiary rights of margin financing. Margin trading: loosened requirement that a margin account will be liquidated if the leverage ratio drops below 130%; brokers will have more liberty in such cases. CFFEX checked index futures trading by 38 QFII investors and 25 RQFII investors and it didn’t find “large scale” short selling activities in the market.

30-Jun-15 Tues Asset Management Association of China (AMAC): 1) requested investors and fund managers to stay rational & not to panic; 2) quoted 13 leading private funds' heads to advocate A-share investment. Bloomberg first reported CSRC may suspend IPO to stabilize the market.

29-Jun-15 Mon SSF: MOHRSS and MOF circulated a draft policy to allow basic pension fund to invest up to 30% into the A-share market; the consultation will end on 13 Jul 2015. People’s Daily said pension fund’s stock investment will be no more than Rmb150bn. CSFC said risks of margin financing & margin calls are relatively small.


27-Jun-15 Sat PBOC cut interests rate by 25bps and cut targeted RRR for selected FIs, effective on 28 June.

 

To July 7th... when selling was made "illegal"

 

and since...

  • 22-Jul-15 China's Securities Finance Corp is now among the top 10 shareholders of at least 8 firms.
  • 21-Jul-15 Capital injection of $109b into 3 policy banks ($48b to China Development Bank, $45b to Export Import Bank, and $16 to Agricultural Development Bank).
  • 19-Jul-15 Increased regulations on internet financing and P2P lending. Client funds must be parked at established banks, and more disclosure and clearer warnings about risks required.
  • 16-Jul-15 Thurs China Securities Regulatory Commission (CSRC) requests brokers’ proprietary trading to maintain net purchase on daily basis and it will allow brokers equity investment to exceed risk limit during special period. Report that roughly $483 billion was made available to China Securities Finance Corp to support the stock market was leaked ($209b of which from China's biggest banks).
  • 15-Jul-15 Weds China Securities Depository and Clearing Co., Ltd (CSDC) to extend business hours for major shareholders to increase their own companies stock holdings.
  • 13-Jul-15 Mon CSRC probed a leading vendor of trading system Hundsun Tech (600570 CH) for its possible facilitation of OTC margin financing; several large OTC margin financing lenders suspended businesses. China Financial Future Exchange (CFFEX) further tightened control over financial futures' trading: 1) if the market moves one-way for two consecutive trading days, it may tighten the trading via raising the margin, adjusting the trading limits and forcing account liquidation; 2) daily one-way trading of SH000905 Index will be capped at 1,200 bills.
  • 10 to 12-Jul-15 Fri-Sun CSRC instructed brokers to regulate external access to trading systems on Jul 12. Police: found clues that some trading companies might have manipulated stock futures. Cyberspace Admin: banned all advertisements illegally promoting unauthorized margin loans.
     

So why did we not see this?

 

Simple, because China just exposed the rest of the world's manipulation is not omnipotent. As Stephen Roach, writing at Project Syndicate, notes, market manipulation has become standard operating procedure in policy circles around the world. All eyes are now on China’s attempts to cope with the collapse of a major equity bubble. But the efforts of Chinese authorities are hardly unique. The leading economies of the West are doing pretty much the same thing – just dressing up their manipulation in different clothes.

Take quantitative easing, first used in Japan in the early 2000s, then in the United States after 2008, then in Japan again beginning in 2013, and now in Europe. In all of these cases, QE essentially has been an aggressive effort to manipulate asset prices. It works primarily through direct central-bank purchases of long-dated sovereign securities, thereby reducing long-term interest rates, which, in turn, makes equities more attractive.

 

Whether the QE strain of market manipulation has accomplished its objective – to provide stimulus to crisis-torn, asset-dependent economies – is debatable: Current recoveries in the developed world, after all, have been unusually anemic. But that has not stopped the authorities from trying.

 

In their defense, central banks make the unsubstantiated claim that things would have been much worse had they not pursued QE. But, with now-frothy manipulated asset markets posing new risks of financial instability, the jury is out on that point as well.

 

China’s efforts at market manipulation are no less blatant. In response to a 31% plunge in the CSI 300 (a composite index of shares on the Shanghai and Shenzhen exchanges) from its June 12 peak, following a 145% surge in the preceding 12 months, Chinese regulators have moved aggressively to contain the damage.

 

Official actions run the gamut, including a $480 billion government-supported equity-market backstop under the auspices of the China Securities Finance Corporation, a $19 billion pool from major domestic brokerages, and an open-ended promise by the People’s Bank of China (PBOC) to use its balance sheet to shore up equity prices. Moreover, trading was suspended for about 50% of listed securities (more than 1,400 of 2,800 stocks).

 

Unlike the West’s QE-enabled market manipulation, which works circuitously through central-bank liquidity injections, the Chinese version is targeted more directly at the market in distress – in this case, equities. Significantly, QE is very much a reactive approach – aimed at sparking revival in distressed markets and economies after they have collapsed. The more proactive Chinese approach is the policy equivalent of attempting to catch a falling knife – arresting a market in free-fall.

 

There are several other noteworthy distinctions between China’s market manipulation and that seen in the West.

 

First, Chinese authorities appear less focused on systemic risks to the real economy. That makes sense, given that wealth effects are significantly smaller in China, where private consumption accounts for just 36% of GDP – only about half the share in more wealth-dependent economies like the US.

 

Moreover, much of the sharp appreciation in Chinese equity values was very short-lived. Nearly 90% of the 12-month surge in the CSI 300 was concentrated in the seven months following the start of cross-border investment flows via the so-called Shanghai-Hong Kong Connect in November 2014. As a result, speculators had little time to let the capital gains sink in and have a lasting impact on lifestyle expectations.

 

Second, in the West, post-crisis reforms typically have been tactical, aimed at repairing flaws in established markets, rather than promoting new markets. In China, by contrast, post-bubble reforms have a more strategic focus, given that the equity-market distress has important implications for the government’s capital-market reforms, which are viewed as crucial to its strategy of structural rebalancing. Long saddled with a bank-centric system of credit intermediation, the development of secure and stable equity and bond markets is a high priority in China’s effort to promote a more diversified business-funding platform. The collapse of the equity bubble calls that effort into serious question.

 

Finally, by emphasizing a regulatory fix, and thereby keeping its benchmark policy rate well above the dreaded zero bound, the PBOC is actually better positioned than other central banks to maintain control over monetary policy and not become ensnared in the open-ended provision of liquidity that is so addictive for frothy markets. And, unlike in the West, China’s targeted equity-specific actions minimize the risk of financial contagion caused by liquidity spillovers into other asset markets.

 

With a large portion of China’s domestic equity market still closed, it is hard to know when the correction’s animal spirits have been exhausted. While the government has assembled considerable firepower to limit the unwinding of a spectacular bubble, the overhang of highly leveraged speculative demand is disconcerting. Indeed, in the 12 months ending in June, margin financing of stock purchases nearly tripled as a share of tradable domestic-equity-market capitalization.

 

While Chinese equities initially bounced 14% off their July 8 low, the 8.5% plunge on July 27 suggests that that may have been a temporary respite. The likelihood of forced deleveraging of margin calls underscores the potential for a further slide once full trading resumes.

 

More broadly, just as in Japan, the US, and Europe, there can be no mistaking what prompted China’s manipulation: the perils of outsize asset bubbles. Time and again, regulators and policymakers – to say nothing of political leaders – have been asleep at the switch in condoning market excesses. In a globalized world where labor income is under constant pressure, the siren song of asset markets as a growth elixir is far too tempting for the body politic to resist.

 

Speculative bubbles are the visible manifestation of that temptation. As the bubbles burst – and they always do – false prosperity is exposed and the defensive tactics of market manipulation become both urgent and seemingly logical.

 

Therein lies the great irony of manipulation: The more we depend on markets, the less we trust them. Needless to say, that is a far cry from the “invisible hand” on which the efficacy of markets rests. We claim, as Adam Smith did, that impersonal markets ensure the most efficient allocation of scarce capital; but what we really want are markets that operate only on our terms.

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As we concluded previously,

The stock market is just too important to leave to the vagaries of an actual market now. Too much depends on good-looking numbers now. It must be guided and controlled, or else the stilts on which our global financial system balances become shakier and more visible. The market must be rendered increasingly meaningless simply because it's too meaningful to our current economic system.