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Innovative products were introduced without adequate risk management. Photo: Reuters
A government crackdown on allegedly illegal high-frequency trades during the summer's stock market meltdown has highlighted loopholes and the need for better oversight of the system.
The Ministry of Public Security said on Sunday that it had arrested two executives from Jiangsu-based and Hong Kong-owned fund Yishidun for allegedly pocketing billions of yuan from irregular futures trades by using software in June and July that in some cases took only one second to buy 31 contracts.
Yishidun general manager Gao Yan and senior executive Liang Zezhong were both arrested for allegedly buying and selling futures in prices that deviated from market standards and illegally made more than 2 billion yuan (HK$24 billion), Xinhua said. Jin Wenxian, a technical executive with China Fortune Futures, was also arrested.
The trades allegedly took place as the authorities, including the central bank, scrambled to pull the stock market out of a death spiral with massive intervention. The benchmark Shanghai Composite Index fell below 3,000 in late August from an all-time peak of 5,166 on July 15.
Renmin University economist Zhao Xijun said the crisis and the clumsy official response exposed the lack of effective regulation of new financial products and transactions. "[The crisis was a result of] transplanting a market mechanism and approach from the United States into a Chinese reality," Zhao said.
"[The regulators] introduced innovative products, such as stock index futures, margin trading and short selling, but the risk management was not in place and responsibility was divided among different authorities, leaving loopholes."
High-frequency trading is a popular high-speed automated transaction method in the US and Europe. It is relatively new but gaining popularity in China, used mainly in transactions involving stock index futures, short selling and exchange-traded funds.
"As long as it is not banned by regulators, we can use high-frequency trading. But once it causes abnormal market movements, the regulators will intervene," an executive with a Shenzhen brokerage firm said.
Before the summer there were no rules covering high-frequency trading on the mainland, leaving the way open for some to exploit loopholes. Photo: EPA
Before the summer there were no law or rules covering high-frequency trading on the mainland, leaving the way open for some to exploit loopholes.
Gao, Liang and Jin were suspected of using others' futures accounts, transferring funds overseas via underground banks, and using high-frequency software developed overseas to invest in and manipulate the stock market, Xinhua said.
It was not until October 9 that the securities watchdog unveiled draft rules to govern high-frequency trading, including a net daily purchase quota and information disclosure requirements.
Read more: Beijing investigates senior figure at China’s state securities regulator in latest step to crackdown on market irregularities
Zhou Jianhua, a strategist with Central China Securities, said China's oversight of automated and insider trading was not on par with regulatory regimes in place elsewhere.
"But the direction of regulation is correct. The regulators have to clean up the foul play in the market and rats in the regulatory body before setting up rules governing financial transactions," Zhou said.
The China Securities Regulatory Commission said on July 31 that it limited transactions on 24 accounts which frequently submitted bids for shares and bid cancellations that were suspected of affecting transaction prices.
Police arrest China's 'No 1 hedge fund manager' in insider trading investigation
Investment wizard likened to Warren Buffett is latest casualty in probe of market irregularities
Xu Xiang during his arrest on Sunday. He had been likened in China to Warren Buffett. Photo: SCMP Pictures
Police and regulators have had their eyes on Xu Xiang, general manager of Zexi Investment and regarded by many as China's No1 hedge fund manager, ever since the losses caused by the chaos in mainland stock markets this summer climbed into trillions of dollars.
And now they have pounced. Xu and several other executives of Zexi were arrested on Sunday on charges including insider trading and stock market manipulation, Xinhua reported yesterday, citing the Ministry of Public Security.
Many had thought Xu was in the clear after an earlier interrogation by regulators over suspicious trades following the boom-to-bust cycle in the A-share market in mid-June.
The detention of Xu, whose aura on the mainland is akin to that of Warren Buffett in the West, is the latest crack to appear in the country's securities industry - cracks that have been appearing despite Beijing's efforts to bolster investor confidence.
A fund manager said Xu was well-connected with senior government officials and a "cunning" asset manager who could fully take advantage of regulatory loopholes to profit.
Read more: Crackdown on Chinese stock market meltdown trades exposes faults in the system
"It was widely believed that he was safe after being interrogated," the fund manager said. "He understands the rules better than any other fund manager and it should have been difficult for police to spot his illegal behaviour."
Zexi's hedge funds recorded at least 140 per cent growth in net asset value this year, making the company controlled by Xu the standout performer in the mainland's securities industry.
"He was viewed as the best of the best before the investigation into him was announced," said Zhou Ling, a hedge fund manager at Shanghai Shiva Investment.
"His detention shows there is no God in this market at all.
"It was the inside information and conspiracy that helped him to make a killing."
The benchmark indicator jumped nearly 120 per cent between October 2014 and mid-June 2015 before slumping more than 32 per cent in three weeks.
Beijing shelled out more than 1 trillion yuan (HK$1.22 trillion) in rescue funds to underpin the falling market, but in vain.
In recent months, more than a dozen powerful industry figures including Zhang Yujun, an assistant chairman of the China Securities Regulatory Commission, and Cheng Boming, president of Citic Securities, the mainland's largest brokerage, have been taken away for investigation.
Zhang Yujun, assistant chairman of the China Securities Regulatory Commission, has been taken away for investigation. Photo: KY Cheng
Meanwhile, Beijing has placed responsibility for the market rout on a handful of government officials and key market players.
Since July, mainland police have been investigating what officials describe as "malicious short-selling".
The move is part of a widespread crackdown on market irregularities targeting corrupt regulatory officials and unethical fund managers.
In late September, Zexi Investment said it did not even own a stock-index futures account for short selling.
Xu's rags-to-riches tale inspired hundreds of securities industry employees in China.
After graduating from high school, he turned his attention to stocks in 1993 with an initial investment of 30,000 yuan. Mainland media estimate he is now worth billions of yuan.
Zexi Investment founder Xu Xiang was arrested on Sunday. Photo: SCMP Pictures
The uncanny parallels between billionaire Xu Xiang's stock picks and the targets of government rescue funds have added weight to suspicions about widespread collusion linked to the A-share market's roller-coaster ride over the summer.
Xu was arrested on Sunday over suspected insider trading and market manipulation. His hedge funds had several large holdings of stocks that were chased by an institution distributing government rescue funds, according to data in the listed firms' quarterly reports.
Xu, 37, founder and general manager of Zexi Investment, has been lauded on the mainland for his investment decisions.
As the benchmark indicator sank 35 per cent in three weeks from mid-June, five of Zexi's funds reported at least 20 per cent growth in net asset value. At least three of Zexi's heavily held stocks - real estate developer Deluxe Family, Shanghai Metersbonwe Fashion & Accessories and Eastern Gold Jade - became darlings of China Securities Finance Corporation, the platform the government used to stem a sharp fall to bolster investor confidence.
Read more: ‘China’s Warren Buffett’ mocked by internet users after he is arrested in ‘doctor's jacket’
Xu's arrest comes as investigations continue into the activities of more than 10 Citic Securities officials, including president Cheng Boming.
"Xu's detention has fuelled speculation that Zexi colluded with some of those who managed the rescue funds to make illegal profits," hedge fund manager Dong Jun said. "It would be naive for people to believe the [market] synergy was only a coincidence."
The Ministry of Public Security established a special task force in early July to look into suspicious trades described as "malicious short-selling".
Read more: Zexi Investment's Xu Xiang: The self-made man with the Midas touch
The market has been rife with conspiracy talk since the death spiral that wiped nearly US$5 trillion off the value of mainland stocks.
In late August, state-owned Securities Daily said some managers of the rescue funds had colluded with foreign investors to take advantage of the more than 1 trillion yuan (HK$1.22 trillion) pumped into the system by the government.
Zexi was forced to deny one market rumour that Xu worked with Citic Securities to use the rescue fund to rig the price of Metersbonwe.
Xu and his subordinates at Zexi are known for their bold investment strategies.
Zexi would often chase stocks that rose to the 10 per cent daily trading limit, a risky move given the high chance of profit-taking.
"They are a one-of-a-kind hedge fund group," Dragon Life Insurance fund manager Wu Kan said.
"They are either heroes or villains, but they did have a big impact on the market."
