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China stock probes send shivers through investment community

Investigations by Chinese authorities into wild stock market swings are spreading fear among China-based investors, with some unsure if they are simply helping with inquiries or actually under suspicion, executives in the financial community said.

Chinese fund managers say they have come under increasing pressure from Beijing as authorities' attempts to revive the country's stock markets hit headwinds, with some investors now being called in to explain trading strategies to regulators every two weeks.

Ironically, the impact may be the opposite of what is intended. By frightening fund managers, Beijing risks accelerating the market selloff and puts other wider policy goals, including the increased use of the yuan abroad, at risk.

One manager at a major fund—part of the "national team" of investors and brokerages charged with buying stocks to revive prices—said a friend, also an executive at a large fund, was recently summoned for a meeting with regulators, along with all other mutual funds that had engaged in short-selling activity.

China stocks
Jason Lee | Reuters

"If I don't come back, look after my wife," his friend told him, handing the manager his home telephone number.

China has unleashed a volley of measures to try to prop up its stock markets that have fallen around 40 percent since mid-June, pushing domestic brokerages and fund managers to buy up shares and banning investors with large stakes from selling their holdings for six months.

The authorities' meddling has unnerved many investors, leaving them questioning China's commitment to liberalizing its capital markets and the long-term future of the country's stock markets themselves.

Adding to those concerns is the fact that authorities have also been probing investment funds' trading strategies, looking into whether they have been engaging in alleged "malicious" short-selling or market manipulation.

On Monday, Bloomberg reported that Li Yifei, the China chairwoman of Man Group, one of the world's largest hedge funds, had been taken into custody to help with inquiries.

Reuters has not independently confirmed the report, while Li's husband has said she is having "normal" discussions with regulators. Man Group shares fell as much as 6 percent on Tuesday following Bloomberg's story.

Foreign fund fears

Sources told Reuters that the increased tempo of meetings with regulators has become intimidating, especially for foreign funds used to relying on their Chinese brokers to represent them when dealing with Beijing.

While foreign investors are unlikely to be a major factor behind stock market swings, given their relatively low participation in the market compared with domestic players, they are seen as more politically vulnerable to investigations.

"The foreign fund community definitely feels like it is being monitored more carefully than it's been in a very long time," said one foreign fund manager.

"Nobody is pointing at you and saying you are doing anything illegal. But it's enough to ask people to walk through all their trades, and 'why is this account trading so much?' That ramps up the pressure".

Some Chinese believe the collapse in Chinese stocks was engineered by foreigners, and there has been speculation that it was caused by the U.S. government to embarrass China as the International Monetary Fund (IMF) considered including the yuan in its currency basket.

Some market participants have also said that gyrations in Chinese shares could lead to U.S. index provider MSCI further delaying the inclusion of A-shares in its benchmark emerging markets index.

If implemented, the inclusion would draw hundreds of billions of dollars into Chinese stocks and strengthen the yuan's global stature.

MSCI said on Tuesday that recent volatility in Chinese shares, and the authorities' interventions to stop the rout, would not be a factor in deciding whether to include China-listed shares.

There are no signs yet that pressure has caused foreign funds to withdraw from the market altogether or pull out staff from the country.

But fund experts say there is a risk that if foreign investors feel intimidated enough that they can no longer employ trading strategies to allow them to profit from volatility, they may eventually have little choice but to leave, for the short term at least.

"This crisis has highlighted the need for a China-specific investment model. Simply porting strategies that worked in the U.S. is not feasible," said Daniel Celeghin, a consultant to hedge funds as Head of Asia Pacific for Casey Quirk based in Hong Kong.

For Chinese funds though, the option to pack up and leave isn't there, and if the volatility continues, the pressure on them is likely to intensify.

The "national team" fund manager said that as well as meetings with regulators, they are now calling him every day to ask how much he is selling and buying.