Chinese hedge fund manager Yuan Yuwei made lucrative short-selling bets against stocks such as New York-listed Starbucks Corp, Yum China Holdings Inc, and Walt Disney Co, as the novel coronavirus swept the globe this year. "Short-selling in China is too inefficient. Either stock is not eligible to borrow, or it takes too long," Yuan, who runs a global macro fund for Olympus Hedge Fund Investments, said. Short sellers are selling borrowed shares hoping to buy them back as prices fall and pocket the difference. Those like Muddy Waters', Carson Block, and Wolfpack Research's, Dan David have made their name shorting Chinese stocks but, like Yuan, their bets were against stocks in New York or Hong Kong, not Shanghai or Shenzhen. This could be shifting. Regulators relaxed short-selling rules last Friday for Shenzhen's $1 trillion startups the board, ChiNext, for participants in the domestic market. They are even considering letting foreigners borrow or shortening inventories on the mainland. Such reform could boost competitiveness and bring the markets of China a step closer to more robust capital-raising centers like New York and Tokyo. Shares loaned for shorting in Shanghai and Shenzhen as of June 16 totaled $3.96 billion compared to an $8.9 trillion stock market capitalization – a 0.044 percent ratio, official data showed. While markets do not exactly calculate short data, in the same way, IHS Markit figures show a short interest of $780 billion in the United States or 2.4 percent of the market cap, and 1.5 percent in Tokyo. However, due to restructuring, Broker Transformer Securities estimates that China's short selling is expected to rise 10-fold this year, and double next year.

REAL REFORM

Changes on Friday mark a major shift since 2015 when regulators blamed "malicious" short-sellers for "manipulating" the futures market illegally and triggering a crash. Regulators, who are keen to attract foreign capital, said they are more open to shorting as a hedging strategy used by long-term investors and as a way of profiting from betting on stocks considered overvalued. Regulators also hope that it can act as a stabilizing force if the bearish views of short-sellers help limit speculative bubbles. Their ChiNext improvements, potentially effective from August, are part of revisions to the listing structure for the board. Under these amendments, it would be permitted to lend stock to a broader community of domestic players, including institutional investors, mutual fund managers, pension funds, and insurers. Also, investors will be able to shorten stock as soon as it debuts, compared to the three-month lag on the mainboard. Although borrowers and lenders are still expected to conduct transactions through China Securities Finance (CSF), both will be given more room for negotiating terms of the contract.

FRICTION

While the reform is welcomed, participants said it might not be straightforward to implement. One problem lies in finding borrowing shares. "Many Chinese institutions trade frequently for quick profit-making them unlikely lenders," said Full Harvest's Wang. The cost of a centralized system, designed to ensure government oversight, is another issue. "When you have CSF as a middleman, you add friction. They also charge you another two percentage points," said Fang Ming, vice general manager of hedge fund house MingShi Investment. Fang and others said allowing participants to set their terms would help, but not solve, the problems posed by getting a middleman.

ULTIMATE TEST

The amendments come as support for short-sellers openly pointing out alleged problem companies have increased after a string of accounting scandals, such as those concerning Luckin Coffee Inc, the U.S.-listed Chinese coffee chain those claimed executives falsified last year's revenues in April.   In an anonymous article released by Muddy Waters, Luckin's revenue growth had been challenged two months earlier. Yuan of Olympus said a more transparent system for short selling could help weed out problem companies. Chinese regulators vowed, "zero tolerance" towards fraud at the listed company. The ultimate test for their newly found acceptance of shorting is whether they let those shots be fired by short-sellers, rather than punishing them as they did in 2015. "I could write articles criticizing some listed companies, but I need to be very cautious, and the wording has to be gentle," Xin Chen, professor at the Shanghai Advanced Institute of Finance, told venture capitalists in a recent video seminar. Wolfpack's David put it more simply: "Without some form of freedom of speech, short selling cannot exist." 

THIS ARTICLE DOES NOT INTEND TO HURT THE SENTIMENTS OF ANY INDIVIDUAL, COMMUNITY, SECT, OR RELIGION ETCETERA. THIS ARTICLE IS BASED PURELY ON THE AUTHOR'S PERSONAL VIEWS AND OPINIONS IN THE EXERCISE OF THE FUNDAMENTAL RIGHT GUARANTEED UNDER ARTICLE 19(1)(A) AND OTHER RELATED LAWS BEING FORCE IN INDIA, FOR THE TIME BEING.