"We Arrested Some Folks" - How China "Fixed" Its Stock Market

Early in September, as Beijing was just coming to grips with the fact that stocks can go down as well as up and that artificially propping up the entire market is well nigh impossible no matter how much money you throw at it, we brought you the following rather chilling quote from a fund manager who was “summoned” by authorities in the midst of what amounted to a witch hunt aimed at anyone thought to be responsible for "malicioulsy" taking stocks lower. Speaking to a friend, the fund manager said the following: "If I don't come back, look after my wife.”

That’s a reflection on the sheer absurdity of what took place in China as the Politburo scrambled to restore the country’s equity “miracle” which was of course built on excessive leverage and the opening of millions of new trading accounts by “investors” who in many cases had an elementary school education or less.

The crackdown even extended to journalists including a Caijing writer blamed for triggering the following July 19 drop in CSI futures after suggesting that China’s plunge protection team may be set to exit the market. 

And then there was of course Citic Securities Managing Director Xu Gang, whose high profile arrest shocked local media and another Citic general manager Cheng Boming who was put under investigation for insider trading. Finally, China even fired Zhang Yujun, the so-called "captain of the national team" (the plunge protection team) and assistant chairman at the CSRC. Zhang was let go for "severe violations of discipline."

Now, WSJ is out with a look at Beijing's campaign against Xu Xiang, who runs Shanghai-based Zexi Investment. Here's more:

In the past 10 days, authorities have gone from detaining Xu Xiang, who runs Shanghai-based Zexi Investment, for alleged insider trading and stock-price manipulation, to freezing stockholdings worth more than $1 billion owned by his parents.


Mr. Xu’s detention marked a milestone in Beijing’s far-reaching crackdown on perceived fraud and irregularities in the wake of the summer’s stock-market crash. Authorities have repeatedly railed against short sellers and other traders, alleging “malicious intent” that jeopardizes the country’s financial security.

Not surprisingly, it turns out that it "wasn't possible" for WSJ to reach Xu or his family. 

It wasn’t possible to reach either Mr. Xu or his parents for comment, and it wasn’t clear whether they had legal representation.

Xu's predicament has shaken big investors' already frayed nerves. "After Xu Xiang was arrested, many people got nervous,” a Shanghai-based fund manager, who was himself fined $3 million for stock-market manipulation in September, told WSJ, adding that he's been "studying the rules very carefully" lately. 

Regulators have now resorted to essentially telling money managers what to do. Failing to follow the "rules" could result in your being "summoned":

Fund managers say regulators have been telling them what they like and don’t like via warning letters from stock exchanges to brokers. Piling on buy orders when stocks are rising is bad. Dumping shares when the market is tanking also gets a warning.

 

Short selling—selling borrowed securities in a bet on falling markets or simply to hedge against other bets—is now frowned upon. Sidney Yu, a hedge-fund manager in Shanghai, said he hasn’t been trading in recent months. “I don’t want to get arrested,” said Mr. Yu, who manages the equivalent of about $188 million in assets. “It has become very expensive to short the market, even just for hedging purposes,” Mr. Yu said.

And operation "kill the chicken to scare the monkey" - as the campaign is known - isn't over yet. 

As Reuters reports, yet another official at China's securities watchdog is now under investigation as Beijing is now probing Yao Gang, a vice chairman of the (CSRC) for graft

It was not possible to reach Yao for comment and unclear if he has a lawyer or what the detailed accusations are against him.

 

Yao, 53, is the second senior CSRC official to come under investigation following the market turmoil. He has a doctorate in economics and took up his current job in 2008, according to his official resume.

 

In September, the graft watchdog began a probe into an assistant chairman at the securities regulator called Zhang Yujun, also for suspected serious violations of discipline.

 

China's Cabinet said on Friday it had asked financial regulators to improve their supervision of market players to better protect consumer rights.

So ultimately, Xi seems set to arrest the entire regulatory apparatus - even the officials Li used to prop up the market - and scare the "sell" impulse out of any and all money managers operating in the country on the way to restoring the public's faith in stocks.

Obviously, this does little to bolster China's claims that it's moving towards a more liberal society free from the all-seeing eye of a centralized authority, but in the short-term, that may not matter to Xi. Avoiding the type of social unrest that might well have occurred in the even the market continued its inexorable plunge was most likely Beijing's top priority and on that note, we'll close with the following quote from a retail investor who spoke to WSJ: 

“The authorities have arrested a lot of people, but we still don’t have a clear picture regarding the real reasons behind it. Sometimes we just tell ourselves that we don’t really need to know the truth, as long as the market goes up.”

Indeed.