"The Buttonwood SPV": The Striking Details Of How China's Central Bank Is Directly Buying Stocks

In the latest revelation of just how far China, and its central bank, are willing to go to prop up its ailing local stock market, on Thursday the official Shanghai Securities News reported that China's foreign exchange regulator has bought mainland stocks worth over 27 billion yuan ($4.18 billion) via three low-profile investment firms it controls.

According to Reuters, Buttonwood Investment Platform Ltd, 100 percent owned by the State Administration of Foreign Exchange or SAFE (which in turn is directly controlled by the central bank, the People's Bank Of China) and Buttonwood's two fully-owned subsidiaries, have bought shares in a total of 13 listed companies, the newspaper reported, citing top 10 shareholder lists in the companies latest earnings reports.

The name of this special purpose entity refers to the Buttonwood Agreement, which took place on May 17, 1792, and started the New York Stock Exchange. This agreement was signed by 24 stockbrokers outside of 68 Wall Street New York under a buttonwood tree.

As Shanghai Securities News reported, the investments are part of SAFE's strategy to diversify investment channels for the country's massive foreign exchange reserves. Recent earnings filings show Buttonwood is among the top 10 shareholders of Bank of China, Bank of Communications, Shanghai Pudong Development Bank , Everbright Securities and Industrial and Commercial Bank of China.

In other words, the PBOC is now directly (as opposed to previously, when its interventions were indirect at best) propping up the stock market itself. The government also uses Central Huijin Investment Ltd, and China Securities Finance Corp, the state margin lender, to buy A shares. This makes China the second prominent central bank to be directly involved in stock purchases after the BOJ which has been buying ETFs and REITs for years, and the SNB of course, which as is well-known has an equity portfolio worth nearly $100 billion.

The Chinese official publication adds that Buttonwood was the vehicle SAFE used to invest in China's Silk Road Fund, which was launched in December 2014, according to the fund's official website. Buttonwood is a new platform China's government uses to buy domestic shares, according to Shanghai Securities News.

Why is this above a big surprise? After all, in the aftermath of last year's stock market crash it is well known that the government has been propping up the stock market. As Bank of America explains "it is a big surprise to us that SAFE bought stocks directly in 4Q. This broke at least two conventions for central banks: 1) central banks do not normally buy stocks directly (as they are supposed to manage their balance sheet conservatively); and 2) FX reserves, presumably what SAFE had used to buy A-shares, should not be used to purchase domestic assets."

As BofA's David Cui further explains, "by now, the three main government bodies that run the economy, the financial system or regulate the market all have a direct stake in the market, literally" and warns that "while many may view this as supportive of the market, we believe that allowing "referees" to become "players" is a slippery slope that could do damage to the market in the long run."

Then again, if every other central banks is doing it...

Here is David Cui's full note:

SAFE’s A-share purchase, a step in the wrong direction

Key takeaways

  • SAFE became a top 10 shareholder in at least 10 A-share companies in 4Q, a big surprise to us.
  • By now, policy makers (PBoC, MoF and CSRC) all own stocks via vehicles controlled by them. Policies could become compromised.
  • PBoC's direct buying is particularly worrying, as its action has monetary implications (albeit on small scale at this stage).

Many government arms now have stakes in A-shares, literally

Shanghai Securities News reported today that SAFE (under PBoC), through its three investment arms, became a top 10 shareholder in at least 10 A-share companies in 4Q15. On March 29, Securities Times reported that Huijin (a subsidiary of CIC, which is under the State Council and has a close tie to the MoF) was among the top 10 shareholders in five ETFs at the end of 2015. We also know that CSFC (under CSRC) bought heavily in the market last year (Government A-share stabilization program: the price may be too heavy, Nov 13). So, by now, the three main government bodies that run the economy, the financial system or regulate the market all have a direct stake in the market, literally. While many may view this as supportive of the market, we believe that allowing "referees" to become "players" is a slippery slope that could do damage to the market in the long run.

What and how much SAFE has bought

The 10 stocks identified by the paper belong to a broad spectrum of sectors: banks, brokers, port operators, telecom, machinery, defense, and a local government investment holding company. SAFE's stakes in these ten companies are worth some Rmb27bn. We don't know how much in total SAFE has spent, as many A-share companies are yet to report. In addition, if SAFE's stake is less than 5% or not big enough for it to be among the top 10 shareholders, companies are not obliged to disclose it. That said, the size of the purchases appears moderate so far.

Why SAFE's buying is particularly problematic

The moderate size notwithstanding, it is a big surprise to us that SAFE bought stocks directly in 4Q. This broke at least two conventions for central banks: 1) central banks do not normally buy stocks directly (as they are supposed to manage their balance sheet conservatively); and 2) FX reserves, presumably what SAFE had used to buy A-shares, should not be used to purchase domestic assets. When the FX reserves were created, the equivalent amount of local currency was already issued on the back of the FX; using FX to buy domestic assets means that more local currency is created with the same FX backing.

A more transparent way to handle this, and with the same result, is for PBoC to simply expand its balance sheet and take on these stocks without going through SAFE. PBoC's loaning to CSFC and brokers to buy stocks was controversial enough, buying stocks directly is a step further, in our view. It is difficult for us to gauge the reasons behind SAFE's move. But this cannot be enhancing public confidence in the PBoC and, by extension, in RMB, in our view (What may trigger financial instability, Jan 3).

Macro policies may become compromised

Macro policies should be about healthy economic growth, which underpins the attractiveness of a country's stock market in the long term. Many of the government's A-share market interventions, including its direct stock buying, are undermining China's growth prospects, in our opinion, due to unnecessarily fast money growth and potentially crowding out of private investment, among other things. Now that the key macro policy makers own stocks themselves, there is a risk that their policies may become more pro-market than necessary, in our view (especially if their market positions continue to expand).

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Now if only we knew how much crude oil the PBOC - which is now clearly coordinating with the Fed in global plunge prevention - was also buying, all our questions for the past quarter would have been answered.