China Curbs OTC Derivative Lending for Equities in Latest Regulatory Push

The move effectively bans the lending of OTC derivatives, which in essence makes it more difficult to short stocks.

China’s regulatory authorities have continued its crusade to curb margin financing Monday, following a decision to order brokerages to stop offering financing to investors via total return swaps and over-the-counter (OTC) derivatives.

The move effectively bans the lending of OTC derivatives, which in essence makes it more difficult to short stocks. Just last week, the China Securities Regulatory Commission (CSRC) alleviated the shares required to engage in propriety trading, lifting an order that required brokerages each day to buy more shares than they sell.

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Despite this measure however, financial markets in China have still been targeted by a litany of regulatory crackdowns in a bid to secure greater transparency for its domestic markets. This has led to multiple probes and investigation against two of China’s largest brokerage centers.

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China opted to shore up its regulation of total return swaps, long since considered a lax business at Chinese brokerages – the practice facilitated investors to obtain margin financing to invest in listed and OTC stocks. This practice had been instrumental in orchestrating the Chinese stock market crash, which saw nearly 40% of the Shanghai Composite wiped out this summer. Since then, markets have rebounded nearly 20% from August, though headwinds remain.

According to Zhang Xiaojun, a spokesman at the China Securities Regulatory Commission, in a recent briefing on the practice, “Some brokerages have been using the total return swaps to provide margin financing to clients for their stock trading. This deviates from their role as a risk management tool.”

Indeed, Chinese brokerages have been under the microscope this November. Last week, the Securities Association of China initiated an investigation into CITIC Securities, a day after it announced an error that had inflated its derivatives business by $170 billion in the period between April and September.

It will be curious to see whether the heightened measures, regulatory crackdowns, and probes help foster higher transparency in the country. Additionally, investors and Chinese regulators will be eying a continued market recovery in tandem with these compliance measures.

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