As international markets tumbled in September 2008 in the wake of the spectacular collapse of Lehman Brothers and the nationalisation of AIG, securities regulators around the world began to clamp down on short selling. The US Securities and Exchange Commission promulgated an order to halt short selling in financial stocks in order to “protect the integrity and quality of the securities market and strengthen investor confidence”, while the Australian Securities and Investments Commission banned all short selling in stocks to protect the Australian financial markets. Financial regulators in the UK, in Taiwan and in other countries took similar measures. Actions by the Chinese government stood out in sharp contrast. The State Council, which is the primary administrative authority in China and is headed by Premier Wen Jiabao, based on a recommendation from the Chinese Securities and Regulatory Commission, or CSRC, agreed to permit Chinese investors for the first time to borrow stock. This decision would theoretically permit short selling and margin lending. It has now been nearly one year since this approval and yet China seems no closer today to the actual launch of short selling than it was then.

The false start of short selling in China’s equity markets, known as the A-share market, has the feeling of déjà vu all over again. In 2006, the market was abuzz with the opening of the China Financial Futures Exchange, which was established to be the first exchange for the listing and trading of index futures contracts, as well as other financial derivatives. The Futures Exchange would allow investors for the first time to hedge their long exposure as well as to speculate and profit from drops in the underlying indexes, upon which the futures contracts are based. It was widely believed, based on comments from the CSRC, that index futures would begin trading by the start of 2007. By late 2007, CSRC Chairman Shang Fulin stated that all systems and technical issues had been completed, but final “preparations” were still needed. The New Year came and went. Once again the market speculated that futures trading would begin following the 2008 Beijing Olympic Games with contracts to be based on the CSI 300, a market-cap weighted index representing the 300 largest companies in the A-share market. The next speculated launch date was the start of 2009. Today, the Futures Exchange’s own website states that “it won’t be long for the CSI 300 index futures...to be launched.” Many investors are wondering why index futures trading has not yet occurred.

Bond futures unsuccessful
China’s unsuccessful experiment with a bond futures market in the mid-1990s goes a long way to explain why index futures trading has been so slow in launching and why short selling is even further away from being a reality.

In late 1992, China launched a market in government bond futures. Due to insufficient institutional interest, the market was opened to the public in 1993. However, it was plagued by rampant price-manipulation and collusion, frenzied and chaotic speculation, and weak governance. In one example of the many problems, price manipulators who held long spot positions colluded before government bond futures matured by accumulating large positions in long futures without the intention to offset. This caused spot prices to rise sharply. Instead of creating a more transparent and stable market for government bonds, the bond futures contracts actually led to higher market volatility, causing painful disruptions in the spot market. As there were no securities laws, and a lax and ever-evolving regulatory environment, problems persisted and multiplied. After less than two years of operation, the market was closed down. The Chinese government certainly wants to avoid an embarrassing repeat of the bond futures market fiasco, this time under the spotlight of the global financial press.